Currency Forecast - Sterling Vs. Euro 23/06/2010

The long awaited emergency budget has given sterling a noticeable boost as markets took comfort from the firm but measured response to the worst sovereign debt threat that has faced sterling for many years. Around 23% of the reduction on the deficit will be achieved through extra tax, most notable a VAT increase to 20% and an increase in capital gains tax from 18% to 28% for higher rate tax payers. That leaves 77% to be saved from public spending cuts which include a freeze on public sector pay and other cost cutting measures that will see up to 25% spending cuts across many departments. The market is now waiting for the reaction of ratings agencies, who are expected to affirm if not applaud the chancellor's plans.

Sterling is accurately reflecting what everyone is feeling about this budget. It was probably necessary and could have been worse, and the general feeling is one of relief. For that reason the pound is now touching 18 month highs and looks to have positive momentum behind it. We remain optimistic of further gains in the short term. Buyers of the Euro should consider placing limit orders to capture any further upside movement. It would take a break below 1.1900 (Monday's low) to cause concern.

Currency Forecast - Sterling Vs. Euro 09/06/2010

Sterling has continued to outperform the Euro over the last week as sovereign debt stories dominate the news wires. The pound took a blow yesterday when ratings agency Fitch said that the UK faces a "formidable" challenge in reducing the deficit and stabilising government finances. However, markets were not unduly effected because this is nothing new. The prime minister has been voicing similar concerns, leaving markets torn between punishing the pound for our weak financial situation, and rewarding the currency because at least the government are aware of the challenge and are expected to take steps aimed at addressing the deficit in the emergency budget due on June 22nd.

On balance, sterling is being given the benefit of the doubt, especially when compared to the Euro. The recent €750bn rescue package did little to calm markets because it's aimed at filling a hole rather than addressing long term structural concerns. ECB chairman Jean Claude Trichet is speaking later today ahead of tomorrow's ECB policy meeting. Markets will be watching closely for any additional measures to shore up the Euro, or for signals or comments that could impact sentiment toward the single currency's problems.

Today's chart shows the Sterling / Euro exchange rate from March 2008 to present. There are two key levels at work at the moment. Sterling captured the key 1.1900 level last week, and has spent the last few days cementing that victory which is certainly good news; but our second level, 1.2142 is still presenting a significant barrier. That level was an important peak back in November 2008, and if the pound could manage to progress above there we would be optimistic that a further rally up towards 1.2800. We remain positive on Sterling's near term prospects, but clients with Euro requirements should strongly consider "locking in" some of the recent gains by hedging at least half of any exposure now.

Currency Forecast - Sterling Vs. Euro 02/06/2010

The Euro continues to suffer from fallout over the series of European sovereign debt stories that have gripped the financial headlines over recent weeks, falling to the lowest level against the US dollar since April 2006, and also allowing sterling to break new high ground above 1.19 yesterday for the first time in 18 months. Sterling was given a boost after Prudential Plc withdrew from its bid to buy American insurer AIG's Asian business.

When the bid was originally announced in March, Pru entered into currency hedging contracts, buying the US dollar and selling the pound in preparation for the transaction. When the bid collapsed, the currency hedges would need to be unwound by selling the dollars and buying sterling again. It was this news that sent sterling sharply higher yesterday. The good news is that although the rally is largely technical in nature, we have now captured an important barrier at 1.1900 (the June 2009 high), leading some analysts to speculate that sterling will continue to improve toward the next noteworthy resistance level at 1.2140 (the peak in late November 2008).

On the data front, UK mortgage approvals rose slightly more than forecast in April, as did manufacturing data. The purchasing managers index remained at 58 for May, steady from April's reading, indicating a continued expansion in activity. Although manufacturing output is still 10% below pre recession highs, the PMI reading is the highest in 15 years, which suggests that manufacturing is rapidly recouping the losses suffered during the recession.

Data is starting to support the idea of a sustained recovery, but the concern is that the euro zone debt crisis could hit demand for UK exports, and austerity measures expected in the June 22nd emergency budget are also likely to dent the recovery. This must also be balanced against the fact that the UK is at least able to take relatively decisive action to curb the deficit, whereas Europe when viewed as a whole will struggle to retain credibility based on recent events.

The technical outlook is positive, but we continue to advise clients to hedge half of any Euro requirement. Sterling has won a minor victory by capturing the 1.1900 level, and must now hold on to this level if it is to sustain the positive momentum.

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