Too much of austerity at a fast pace may prove counterproductive

Too much of austerity at a fast pace may prove counterproductive

Good morning and welcome to today’s foreign exchange market commentary on Friday, the 20th of April.

The chatter over extra funding to the IMF for bailing out Spain and Italy is getting louder. The prospect of the IMF sealing its kitty with more than $400 billion in fresh funds, as wished by Christine Lagarde, seems to come to fruition as the emerging economies line up fresh funding apart from the trillion euro rescue funds already in place.

The eurozone members are unlikely to meet their budget deficit targets. The IMF has stepped in to suggest that greater austerity doesn’t necessarily translate into better fiscal position. Strict central bankers and populist political leaders should take note; too much of austerity at a fast pace may prove counterproductive.

The IMF is citing the case of France and Spain as example. Both the countries were supposed to bring down their deficits to 3 percent next year, but will the targets. While the French deficit will be closer to target at 3.9 percent, Spanish deficit is expected to miss the target by a wide margin – 5.7 percent of GDP.

That was a steep target for Madrid since Spain had a deficit of 8.5 percent in 2011. Cutting deficits by 5.5 percent over two years required exceeding painful reforms that risked of a raising a severe political storm.

For Paris, the IMF report is an eye opener. A economy heavily dependent on government spending – 56 percent of French GDP is public-sector spending, is far more susceptible to shocks from a sudden roll-back. France can’t afford to wait to get back the region to pick up, especially with the anemic growth forecast this year and the next (0.5 percent and 1 percent respectively).

CURRENCY RATES OVERVIEW

GBP/EURO – 1.2216
GBP/US$ – 1.6057
GBP/CHF – 1.4683
GBP/CAN$ – 1.5981
GBP/AUS$ – 1.5541
GBP/ZAR – 12.561
GBP/JPY – 131.09
GBP/HKD – 12.464
GBP/NZD – 1.9741
GBP/SEK – 10.791

EUR: The single currency started off strongly yesterday after Spain raised €2.5 billion successfully through 10-year bond auctions but later came down to earth as investors forced Madrid to pay higher yields on the country’s budget deficit worries. The GBP/EUR pair continued to march ahead as Spanish equity markets tumbled to a two year low and hit 1.2251 in the day’s trading. The German IFO numbers are expected today, but more importantly it’s the UK retail sales number that will decide the pair’s movement this week. The GBP/EUR opens at 1.2218 this morning.

USD: The cable rallied against the greenback yesterday, hitting a high of 1.6078, its highest level since November 14. The strength however, could not be sustained as risk appetite diminished following rumours of French sovereign downgrade. Also weaker than estimated job-loss claims, existing home sales and Philly Fed survey increased safe haven asset demand. The noise over an impending QE3 by the Fed grew louder after yesterday’s numbers. The GBP/USD pair opens at 1.6066 this morning.

 

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