Thursday 17th May 2012
Good morning. The volatility continues in the currency markets, with the EU debt crisis and Greece’s problems continuing to drive exchange rates. Earlier in the week we hit new highs of €1.2580 against the Euro, however as is often the case, the gains were short lived. Sterling has now started to weaken following grim growth forecasts by the Bank of England. So in today’s posts we’ll look in detail at:
- The EU debt crisis situation; what will happen next?
- What would happen if Greece leaves the Euro?
- Forecasts for Pound/Euro going up in 2012
- Forecasts for Pound/Euro going down in 2012
I’ll then analyse the UK’s economic prospects and look at the arguments for where Sterling/Euro rates could move throughout the remainder of 2012. Let’s start with the obvious – the situation in Greece….
Greek worries weaken the Euro pushing GBP/EUR rates higher.
The failure of Greece to form a government has plunged its membership of the Euro into doubt this week, and is the reason the Euro has weakened so much. Indeed earlier in the week we saw rates get very close to €1.26.
It now looks like Greece will hold fresh elections in June after final talks to form a coalition failed on Tuesday, and this raised new concerns over Greece’s continued membership of the Euro. The uncertainty pushed the GBP/EUR rates up at the start of the week, peaking at a new 3.5 year high of €1.2577.
EU officials fear Greece will elect an anti-bailout government, which could trigger a Greek exit from the euro. That possibility is now discussed openly among Europe’s leaders
So what would happen if Greece leaves the Euro?
For a few years now, everyone has been asking what would happen if Greece left the euro and reverted to the Drachma. It’s not something that would happen overnight, however it is looking increasingly likely. The more uncertainty we see in the euro zone, the more the euro could weaken.
While the question of Greece leaving is real one, the fact remains that there is no mechanism to do so. The possibility was never envisaged when it was created in 1999; to exit the euro it would have to leave the EU. There would probably be an interim period after which any Euros would be converted to Drachma at a pre-agreed rate, much like when countries switch to the Euro. Supply and demand would then dictate the new currencies value. The likely result is the new currency would fall through the floor and inflation would spiral.
So the best case scenario of Greece leaving would leave Greece with no buying power and high inflation. However, with its currency so weak the idea is that the economy would then grow.
Of course at the moment all of this is speculation, and given there is no mechanism for them to leave, even if they decided to do so tomorrow it would take many months before any potential return to another currency would be implemented. So let’s first look at the UK economy and where Sterling could move, and then at the more immediate effects we may see on exchange rates.
Sterling weakens on Bank of England forecasts
Yesterday Mervyn King, governor of the Bank of England said it has cut its growth forecast for this year to 0.8% from 1.2%, saying the Eurozone “storm” is still the main threat to UK recovery. The news shifted focus back towards the UK, and the Pound dropped across the board, bringing rates back down from their recent highs. Indeed I have warned in recent days that the UK is not immune to the EU’s problems, and the markets are now pricing this into the Pounds value.
The Eurozone was “tearing itself apart” and the UK would not be “unscathed”, said Bank governor Sir Mervyn King. He told a news conference that the euro area posed the greatest threat to the UK recovery, and there was a “risk of a storm heading our way from the continent”.
“We have been through a big global financial crisis, the biggest downturn in world output since the 1930s, the biggest banking crisis in this country’s history, the biggest fiscal deficit in our peacetime history, and our biggest trading partner, the euro area, is tearing itself apart without any obvious solution.
On quantitative easing, he said that no decisions had been made whether or not to continue pumping money into the economy. The last stimulus programme was still “working its way through the system.
So will Pound/Euro rates go up or down this year? 2012 forecast
This is what everybody wants to know, but what nobody can predict! Indeed forecasts are differing between some big players. Deutsche Bank have revised their forecasts to rates dropping to €1.16 by the end of the year, citing the fact that the UK economy will be affected byt he EU problems, and further QE is likely which will weaken the Pound. Deutsche Bank trade more currency than anyone else in the world so you should certainly take notice if you need to buy Euros.
In stark contrast however, Barclay’s Capital are forecasting €1.30 by year end due to the EU’s debt crisis. This really shows how uncertain things are going to be this year, but also highlights the huge difference that these levels would make to you if you need to make a large transfer.
Taking the Euro on its own, I would say that it will likely weaken more which should make it cheaper to buy, but what is hard to factor is the effect it will have on Sterling. Half our exports go to the EU so that could push the Pound down, and it wouldn’t surprise me to see Mervyn talk the Pound down some more to help the export led recovery, as he’s not keen on a strong Pound.
So there are logical arguments that point to both rates continuing to rise, and also for rates to drop back below the €1.20 level, and this really illustrates the uncertainty over which way rates will go.
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