Foreign Currency Report 31 July 2008

GBP

Economists predicted on Friday that the UK economy was already contracting and would see overall negative growth for the third quarter of 2008. Forecasts for the first quarter of contraction since 1992 came after official figures on Friday showed growth slowing. In the second quarter of the year construction and manufacturing output fell and the service sector also contracted in May and June following a buoyant April. With this strong April included, the Office for National Statistics said that economic growth slipped to 0.2 per cent over the second quarter as a whole, down from 0.3 per cent growth in the first quarter. The normal quarterly rate of growth for the UK has averaged a little under 0.7 per cent in the past 15 years. The weakness at the end of the period alongside persistently downbeat business surveys prompted many economists on Friday to claim the economy was already contracting.



With the year-on-year growth rate falling to 1.6 per cent in the second quarter compared with 2.3 per cent in the first quarter, the economy's 12-month growth rate is at its lowest since 1993.
But caution is still required with the figures. The preliminary ONS estimate for gross domestic product tends to be revised higher by 0.1 of a percentage point.
Knowing this bias, the Bank of England will not be too concerned that the year-on-year growth figure of 1.6 per cent is below its May forecast of 2.26 per cent for the same period.

USD

The Federal Reserve ramped up its liquidity support operations again on Wednesday in an effort to reduce money market strains and pre-empt the possibility of funding crises at the year-end or at other stress points.

The US central bank said it would offer three-month cash loans to banks and create a new options auction facility. It also said it would give investment banks and other primary dealers extended access to emergency cash and loans of Treasury securities until January 30. The European Central Bank and the Swiss National Bank will also offer three-month Dollar loans through an offshore facility set up with the Fed. The Fed will increase the amount of dollars it provides to the ECB in exchange for Euros by $5bn to $50bn.

Global equities enjoyed further gains on Wednesday as investors took heart from Federal Reserve moves to provide additional support for the US financial system.

Further encouragement for equity bulls came from some positive news on the US labour market ahead of tomorrow's crucial non-farm payrolls report. A rebound for oil prices slowed the momentum of stock market gains late in the day in the US. The Fed said it was extending an emergency credit facility for primary dealers through to January 30 as well as taking other steps aimed at boosting liquidity.

EUR

Problems this week for the ECB came from two senior members of the European Parliament's economic and monetary affairs committee, Pervenche Beres, a French Socialist who chairs the committee, and Werner Langen, a German Christian Democrat. They have recommended that the ECB should reconsider its inflation target in view of higher food and oil prices and move away from a percentage point target to a target band. If adopted, this would almost certainly lead to an increase in the effective inflation target. I think it is a bad idea for a central bank to shift the goalpost when it misses the goal. The ECB's communication problem is based on two misunderstandings. The first is the judgment that "real time" press conferences are the best way to explain policy. Those start with Jean-Claude Trichet, the ECB president, reading out a statement, mostly written before the meeting started. It contains the ECB's internal analysis but it does not reflect the debate in the wider governing council, which also includes the presidents of the national central banks. Nobody could possibly write that fast. When Mr Trichet pre-announced the latest interest rate increase, there was no hint of it in the statement. The announcement came in the answer to a question, an unprofessional way to signal a policy shift - difficult to tell the outcome of next month's meeting by the European Central Bank.

With massive volatility presently in the currency exchange markets, and conflicting data both for and against the moving Central Banks around the world, it is difficult to determine the path of future currency exchange rates. Peace of mind comes in the form of a forward contract - a way of securing your currency exchange rate based on where the forex is currently trading, only 10% down not only allows you to earn interest or release future equities, but lets you know how much to budget for, meaning your forward currency exchange transaction will be guaranteed to cost you no more than today. To learn more about forward contracts or any tools we have to offer at Foreign Currency Exchange, please call +44 (0) 20 7989 0000 or email Tom Walsh on tpw@fcexchange.co.uk.