Quantitative Easing, and the effect on Sterling

4th November 2010
Good morning. Quantitative Easing. The FED did it yesterday to the tune of $600bn. The news has weakened the dollar and pushed rates higher. Today the BoE will announce if they decide to follow suit, in what seems to be developing into a war between economies to weaken their currency. More on this in a moment after the usual snapshot of rates:

  • GBP/EUR 1.1386
  • GBP/USD 1.6174
  • GBP/AUD 1.6032
  • GBP/NZD 2.0508
  • GBP/CAD 1.6248
  • GBP/CHF 1.5652
  • GBP/ZAR 11.018
  • GBP/JPY 130.82
  • GBP/HUF 309.05
  • GBP/AED 5.9348
  • EUR/USD 1.4199

FED announce $600bn Quantitative Easing (QE)

The Federal Reserve has announced that it will pump $600bn (£373bn) into the US economy by the end of June next year to try to boost the fragile recovery. Interest rates are already close to zero, which means the Fed cannot reduce rates any further in order to boost demand – the more traditional policy used by central banks to stimulate growth.

Instead, it has announced a fresh round of QE, in which it will create money to buy long-dated government bonds. The programme has been dubbed QE2, after the Fed pumped $1.75tn into the economy during the downturn in its first round of QE.

Many believe this is less about stimulating the economy and more about purposely weakening the US Dollar. In the last round of QE, the actual effect was hard to quantify. There’s no reason to believe this second round will be any different.

We believe this is more to do with weakening the US Dollar to make it’s exports more attractive, and links into to the possible Currency War we discussed recently.

Bank of England to follow suit?

A few weeks ago most analysts thought that the BoE would indeed embark on another round of QE. However in the last few weeks we’ve had better GDP figures, better manufacturing and housing data, and the recovery looks better than originally thought.

“I think QE is off the table until next year,” said Michael Hewson, market analyst at CMC. “There was a sell-off after disappointing construction PMI but sterling is very susceptible to data news because of the bipolarity of the Bank of England monetary committee.”

The MPC began a two-day meeting with the decision to be announced on Thursday. Sticky inflation in the UK means the BoE is likely to keep policy on hold although there is still an outside chance of more quantitative easing.

Given the fact that economies are purposely trying to weaken their currencies to boost export demand, despite the better figures of late there is still a chance more QE will be announced.

What may be the effect on exchange rates?

If they do announce QE it will likely weaken the pound and push exchange rates lower. If they don’t announce it, Sterling may go higher but for the most part this is already priced into the market, given that most analysts now do not expect further stimulus. The vote split released in 2 weeks will also be closely watched, as in recent months there has been a lack of consensus among the Monetary Policy Committee (MPC), and if there is another 3 way split showing indecision on how to move forwards, this could also weaken the pound.

Today’s Data

Interest Rate decisions for both the EU and UK today. Rates are likely to be left on hold, but if the BoE opt for further stimulus in the form of Quantitative Easing, expect the pound to fall sharply. If no QE is announced, the pound will probably strengthen. Either way we expect movement one way or the other today, so ensure you have discussed your options with us well in advance of today’s release.

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