Foreign Currency Report 4 August 2008

01 January 1970

Sterling Outlook

Last week we saw extreme volatility with the Pound exchange rate and we managed to help our clients take advantage of this. The dire state of the British economy has been the main reason for continued Sterling currency weakness. The British Pound exchange rate remained weak and questioned if GBP/USD would continue to fall. This was indeed the case, as the currency tumbled versus the US dollar, Japanese yen, Euro, and Swiss franc at various times throughout the week. However, this move actually occurred before the release of UK manufacturing PMI, which hit a decade low of 44.3 in July. This was the third consecutive month that this indicator held below 50 – signalling a contraction in business activity – as factories grapple with rising raw material costs and slowing global and domestic demand. This will continue to cause the Pound exchange rate to weaken as the UK economy moves closer to falling into recession.

Some Monetary Policy Committee members of the Bank of England – such as David Blanchflower – see an immediate need to cut rates. On the other hand, the June reading of UK CPI(inflation rate) jumped further above their 2 percent target to 3.8 percent and upside risks remain, which has encouraged the majority of members to leave rates steady at 5 percent. We expect similar sentiment during next week's meeting, as the MPC is anticipated to leave rates unchanged once again. Since they are unlikely to issue a monetary policy statement, the market's reaction to the news should be relatively muted as traders will await the release of the meeting minutes on August 20 as a gauge of the BoE's bias. This said the more negative news for the UK we receive the worse this horrendous situation Sterling is going to get with considerably lower rates being mentioned in the media.

US Dollar

There is the potential for the Dollar exchange rate to weaken off this week. This could make this week the ideal time to purchase Dollars again after weakness a few weeks ago. The US dollar's consolidation continued on Friday as US non-farm payrolls (NFPs) failed to have a lasting impact on the currency. While the currency did initially jump across the majors on the news that NFPs were not quite as bad as expected at -51K (consensus expectation: -75K), the greenback pulled back over the following two hours. There were a few factors coming in to play here. First, the unemployment rate actually rose more than anticipated to a 4+ year high of 5.7 percent from 5.5 percent, highlighting the fact that NFPs have fallen for seven months in a row and the labour markets remain exceptionally weak.

This was followed by the release of Manufacturing output, which fell less than expected to a reading of 50.0 in July (consensus forecast: 49.0) from 50.2, signaling a stagnation of activity in the sector. Looking at a breakdown of the report, an increase in production was offset by a contraction in new orders. The most startling part of the release, however, was the surge in the employment component to 51.9 from 43.7, which indicates a marked rise in hiring. This certainly would have been helpful ahead of the NFP release since it was a bit better-than-forecasts, but at the same time, would have been misleading since the report ultimately reflected net job losses in the sector.

The information above shows us how we can expect to see US Dollar currency weakness for while longer but the US could be recovering slightly, which will lead to Dollar exchange rate strength, meaning Dollars will cost you more Sterling to Purchase.

Looking ahead, Tuesday's Federal Reserve meeting will be THE key event of next week. However, this has less to do with the actual rate decision (the FOMC is widely expected to leave rates steady at 2.00 percent) and more to do with what they say in their subsequent policy statement, as inflation-focused comments could easily drive the US dollar higher.

Euro

The Euro currency zone is now showing signs of faltering. This is on the back of worse than expected German retail sales. While this didn't necessarily impact the currency much, the release will be useful a leading indicator for next week's Euro-zone retail sales report and only adds to the pile of evidence suggesting that economic growth in the region is slowing rapidly. With the CPI (inflation) in the Euro Zone at a 16 year high of 4.1% the ECB (European Central Bank) is expected to leave rates unchanged at 4.25 percent.

This evidence during normal times would usually mean the Euro weakening off and improving the situation for our Euro buyers. However the worsening situation in the UK means that traders are not convinced of the UK economy recovering any time soon. Therefore, in my opinion, Sterling currency weakness is expected to continue and probably worsen over the coming months.

If you wish to discuss your foreign currency exchange requirements or the currency products we offer, please feel free to call James Morley on +44 (0) 20 7989 0000 or email


jam@fcexchange.co.uk