Good morning and welcome to today’s foreign exchange market commentary on Wednesday, the 2nd of January.
Though US fiscal cliff negotiations held the attention of global markets for the last couple of months, the fiscal pile, according to the International Monetary Fund, is the real issue. To bring down the scary public-debt/GDP ratio is the biggest challenge for most of the advanced economies. But most European economies are now struggling with negative growth as governments initiated fiscal consolidation while their economies were still weak. Consequently, debt stabilisation has become elusive.
The consolidation process has just begun in the US while Japan is yet to initiate any such measure. The magnitude of fiscal cutback is more than 10 percentage points of GDP for the US while the effort required for fiscal consolidation for Japan remains out of bounds.
The advanced economies are officially committed to painful austerity measures. While some may seek inflation, still others may resort to measures that force domestic savers to finance the state through low bond yields, or, through outright “haircuts” causing losses to creditors, both public and private.
The above three methods have been implemented in the past and can be viewed as implicit taxes on present and future generations. Should governments blend growth with fiscal consolidation or go for outright restructuring. A mixed approach is more desirable, at least morally, since the other alternatives amount to rejecting the claims of bondholders’ completely.
But governments globally prefer populist initiatives over fiscal prudence and its worth considering the economic implications of traditional and non-traditional choices on efficiency and equity. Large tax hikes may slow down growth since they inhibit investments while public spending-cuts erode infrastructure.
Restructuring, on the other hand, weakens banks which tend to hold large government debts. This diminishes their capacity to fund the economy, undermining the entire financial system as safe-asset role of domestic debts are depressed. However, an exception can be made when both private and public sector debts are high since painful restructures can lead to a debt-deflation spiral, as witnessed in Greece recently. Adjustments through inflation can be a less harmful alternative despite the higher economic costs.
CURRENCY RATES OVERVIEW
GBP/EURO – 1.2278
GBP/US$ – 1.6310
GBP/CHF – 1.4852
GBP/CAN$ – 1.6104
GBP/AUS$ – 1.5576
GBP/ZAR – 13.7665
GBP/JPY – 142.26
GBP/HKD – 12.6482
GBP/NZD – 1.9510
GBP/SEK – 10.5186
EUR: Risk sentiments improved this morning after US lawmakers approved a bill to avoid the so-called fiscal cliff. The Congress voted in favour of a comprise deal that extends tax-cuts for Americans earning below $400,000 annually, up from the $250,000 that President Obama had originally proposed, and delays spending cuts for another two months. The EUR/USD pair rallied to 1.3298 overnight from 1.3190 and fiscal developments are expected to dominate today’s session even though we have manufacturing PMIs across Europe and from the US due for release today. GBP/EUR opens at 1.2290 this morning, close to where it traded before the Christmas break.
USD: The US Congress’ approval of a compromise deal came as a relief for global markets which otherwise would have resulted in automatic tax hikes of $536 billion and spending cuts worth $109 billion from Jan 1st. Results showed 85 Republicans and 172 Democrats voted in favour of the bill with the vote coming only few hours before trading began in the New Year. The pound has surged against the US dollar this morning to a high of 1.6366 from 1.6250 and Sterling is expected to find support against the US unit for the rest of the week over the latest US development. That being said, UK manufacturing PMI, due in the morning today, may have some effect on the cable. The GBP/USD pair is trading around 1.6303 this morning.
Have a great day!