The pound fell against both the euro and US dollar ahead of tomorrow’s Bank of England (BoE) decision on interest rates as markets speculate that the BoE may consider increasing the size of the Quantitative Easing (QE) program by another £25 billion to provide a further stimulus to the UK economy.
Overnight, the US dollar received a strong boost after the release of the Federal Open Market Committee’s (FOMC) minutes were published last night. These showed that only 2 of the 10 members of the committee felt that further QE in the US may be necessary. This is a much more positive outlook for the US economy than Federal Chairman Ben Bernanke pronounced last week.
Like the pound, the euro fell against the dollar but gained over 0.5% on the day against the pound despite the publication of weak euro zone Purchasing Managers’ Indices (PMIs) on the manufacturing sector.
The release in the last 48 hours of better than expected manufacturing data from both China and the US and the dovish minutes from the FOMC) gave some impetus to the market bulls although carry trade currencies remain bearish. The Australian dollar showed signs of weakness after the publication of the Reserve Bank of Australia (RBA) minutes showed another ‘dovish’ message despite the RBA deciding to keep its Australian interest rates unchanged at 4.25%. The RBA did however signal that it may lower rates if inflation permits and explicitly recognised the problems facing households and the domestic economic from a combination of high interest rates and a strong exchange rate.
In euro zone news, Spain continues to make the wrong sort of headlines just as headlines around Greece slip to the back-burner. A general strike last Thursday was followed by an ambitious plan to cut its budget deficit by no less than €27 billion which is sure to provoke further unrest with the unions. Spanish unemployment already stands at a euro zone high with youth unemployment exceeding the 50% level.
Analysts are suggesting further problems for the single currency. Roger Nightingale, an economist from RDN Associates told business network CNBC yesterday that “half the countries in Europe seemed to have a negative last quarter (in 2011) and the first looked worse. I’m amazed that so many people are talking about recovery.”
Holger Schmieding from Bernberg Bank was more “optimistic” and told the agency that Italy and Spain could benefit from their austerity measures and start to show “a comparatively good performance.”
Nonetheless, the Bernberg chief economist sees danger elsewhere, noting that, while attention has been focused on Greece and Spain, Nicolas Sarkozy, president of the second largest euro zone economy, is facing elections this month.
“France is the one big risk to watch in Europe. It’s the one economy which still needs a wake-up call. All other significant economies are already on the step to overhaul,” he warns.
As if to underline the warning, yesterday saw the publication of data from the French economy that gave a further sign of the extreme weakness in the French economy as the country’s manufacturing Purchasing Managers Index hit its lowest level in over 33 months. The PMI was dragged lower by four of its five components in March with the main area of weakness was domestic demand.
Meanwhile, Italy the third largest euro zone economy was the subject of an article in the FT. The article cites a report titled “Budgetary situation in Italy” that warns that the country’s ambitious deficit reduction targets could be jeopardised by recession and relatively high interest rates. The report suggests that “the government should stand ready to avoid any slippage in budgetary execution and take further action if needed.”
The FT reminds us that economists warn that “tax increases (…) are strangling weak consumption levels and that spiral of recession and further austerity would drive Italy’s budget targets even further beyond reach.”
Meanwhile in a glimmer of hope for the long struggling UK economy, a survey of over 8,000 businesses by the British Chambers of Commerce (BCC) showed an improvement in business activity on the last quarter of 2011, when its survey pointed towards a period of stagflation. Its latest Quarterly Economic Survey showed increases in domestic and export activity with more businesses looked to invest in employing more staff, training, and plant and machinery.
David Kern, BCC Chief Economist, said the UK economy was likely avoid a recession, though the erratic construction figures may distort the ONS estimate.