GBP/EUR & GBP/USD Forecast Outlook August 2011

Monday 1st August 2011

As always on a Monday, we’ll take stock of the movements in exchange rates for GBP/EUR & GBP/USD over the last week. In this week’s Report:

• Euro debt again weakens Euro
• US debt issue weaken US Dollar
• Sterling benefits despite continued weak data
• Round up of the week’s data that may affect rates

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Sterling vs. Euro;

Markets continue to expect the Bank of England to hold interest rates at record lows well into 2012, with some speculation that more asset purchases may be needed to revive flagging growth in the UK economy.

After figures showed the economy barely grew in the second quarter, BOE policymaker David Miles said last Wednesday that the recovery appeared to have slowed and there is a risk the economy could tip back into recession. On the upside, analysts said sterling was likely to benefit from any downgrade to U.S. debt by rating agencies as the UK, with a sound fiscal plan in place, is likely to retain its AAA rating.

But austerity measures to curb Britain’s budget deficit are also crimping growth and consumer spending, meaning sterling is unlikely to strengthen significantly in coming months. UK data has been lacklustre of late, with the CBI figures reminding investors that consumers are struggling and that growth in the current quarter is unlikely to be encouraging.

Sterling did however rise against a broadly weaker euro last Thursday as the single currency slipped on lingering concerns about euro zone debt. British retail sales fell at their fastest pace in a year in July and stores expect a further deterioration in August, as hard-hit consumers clamp down on spending, a survey by the Confederation of British Industry showed. Movements in sterling over the past week were largely driven by a broad sell-off in the euro after an Italian bond auction. Also, the pound has benefited as investors have shunned the dollar and the euro due to fiscal issues plaguing those areas, while the UK has been making progress on reining in government spending, although some analysts say this has come at a cost to economic growth.

Commerzbank currency strategist Peter Kinsella said this view would keep the pound supported, but still added the belief that UK interest rates will stay low due to a sluggish economy that would cap any significant upside in Sterling. Many times in July we have seen that data releases haven’t necessarily dictated the movement of the markets, the euro has fallen roughly 3 percent versus sterling so far this month, showing a confused and volatile time for the GBP/EUR cross.

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Sterling vs. US Dollar;

Sterling slipped against the Dollar last Friday, tracking a slide in the Euro versus the U.S. currency after a threat by ratings agency Moody’s to cut Spain’s credit rating prompted some investors to sell riskier currencies for the Dollar. But losses versus the Dollar were limited given that investors remain negative on the U.S. currency as Washington remains far from reaching an agreement on government borrowing before a deadline next week. The Pound ended July around 1.5 percent higher versus the Dollar.

Debt negotiations in the US were hit by further complications at the end of last month as Republican leaders abandoned a vote on plans to increase the debt ceiling after failing to secure enough votes to get the plan approved. This failure gave US politicians 4 days to complete any deal. If they struggle to arrange a deal and the US misses a coupon payment, a technical default would have occurred, but what does that mean for the world economy and the US Dollar?

Any default would lead to a huge adjustment in the value of the Dollar, which would be reinforced by the almost certainty of the Fed starting QE3 to offset the compulsory reductions in governmental spending. We are in uncharted territory in terms of the potential effects on the world economy, particularly with the inter-bank rate which could, according some economists, be affected more by a US technical default than the aftermath of the Lehman Brothers failure.

Some analysts have said Sterling is likely to benefit from any downgrade to U.S. debt by rating agencies, as the UK (with a sound fiscal plan in place) is likely to retain its AAA rating. But austerity measures to curb Britain’s budget deficit are also restricting growth and consumer spending, meaning Sterling is unlikely to soar above the $1.70 level in the coming months.

The US problems would have worrying implications for the European debt markets, since if the safe haven of the US cannot meet its obligations, who can? The recent problems in Spain and Italy would be amplified and may lead eventually to those countries requiring some sort of bail-out. However, since money would have to flow somewhere, the Euro could actually benefit from the US problems. The recent shift away from the Greenback has been profound in all currencies, in the shorter term and over the past weeks, as investors have been protecting themselves from potential Dollar fallout.

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Weekly Economic Data that may affect exchange rates

MondayInflation data and unemployment figures are released from the EU today. In the UK we have House Prices and Inflation data. In the US there are manufacturing prices.

TuesdayAfter the holiday in Australia yesterday, today we have House prices, building permits, commodity Index and an interest rate decision, all of which could strengthen the Aussie. Closer to home, we have Inflation data for both the UK and Eurozone. Also from the UK there are shop price index figures from the BRC.

WednesdayAustralian Retail Sales and Trade Balance figures are released today. From the Eurozone there are also Retail Sales figures. The EU and UK both release Purchasing Managers Index which is a measure of inflation. Stateside, watch for Mortgage Approvals and Factory orders.

ThursdayAs with every first Thursday in the month, the UK and EU announce their latest interest rate decision. Both are expected to leave rates on hold, but watch for any mention of Quantitative Easing from the BoE. The USA has various measure of unemployment.

Friday A busy end to the week, with PPI (Inflation) data from the UK, in addition to Industrial Production figures from Germany. A busy day in the states also, with Unemployment and Non Farm Payrolls at lunchtime.

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