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Central Banks Pave the Way to Short term Pound Revival vs The US Dollar

The Pound is trading at 1.573 today against the Dollar following yesterday’s coordinated action from the US Federal Reserve, Bank of Canada, Bank of England, Bank of Japan, ECB and Swiss National Bank to improve liquidity for banks. The 6 central banks agreed to cut the interest rate on dollar liquidity swap lines by 50 basis points.

Essentially the announcement allows commercial banks to borrow dollars – the staple currency in interbank lending – at a cheaper rate. As a risk aversion technique US Banks charge a deposit in the currency being traded (e.g. UK banks would pay a deposit in Sterling) before they dish out the desired dollars. The reduction allows commercial banks to borrow money at a rate of 0.56% interest reduced from 1.06%, it is planned to last for 14 months.

The official line on the move is:”The purpose of these actions is to ease strains in financial markets and thereby mitigate the effects of such strains on the supply of credit to households and businesses and so help foster economic activity.”

Many investors, financers, and politicians had called for affirmative action and when it came the markets responded with jubilation; the high-yielding commodity currencies such as the South African Rand, Australian Dollar and New Zealand Dollar shot up rapidly, rising 1.5-3% while the safe haven US Dollar and Japanese Yen were punished for their low interest rates and high security.

The announcement appears to be good news for the global economy, at least in the short term; North American and European share prices rose on average over 4%. Italian bonds dropped and German one-year bunds fell below zero for the first time in history, prompting optimism for France and Spain who sold large numbers of bonds today.

It appears however that cheaper dollar swap lines will help commercial banks, and the announcement did give the market something to react to yesterday, but the fact remains that more is needed in the means of fiscal integration to sure up the Eurozone debt crisis. Spain’s 5-year borrowing cost rose to 5.544% today from 4.848% on 3rd November. Spain sold €3.75 billion of bonds but at its highest interest rate in 6 years. Across the board, yesterday’s spikes are falling back down; the commodity currencies are still benefitting from the decision, just not as dramatically as they did upon its announcement.

One question being raised by traders is that of ulterior motives; what does this move suggest for the market? The lower interest rates should help prevent credit shortages which is especially pertinent in the case of emergency e.g. If a Eurozone country defaulted, it would make cash more accessible for the banks that were holding the failed state’s debt. A positive move then? Yes and No. Of course precaution is to be heralded and the affect of the decision was palpably positive, but at the same time the move could be interpreted as rotten with worry; an ominous clue that policymakers foresee a Eurozone state failure.

The Euro’s precarious predicament is not good for the Pound and if the unthinkable happens and a Euro member state defaults, it will be the Dollar that benefits from risk liquidation.

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