The currency blog

Sterling held steady yesterday as the reintroduction of a star chamber to quiz ministers on spending decisions marked the start of the Governments formidable challenge of reducing its €156 billion budget deficit. The last time a star chamber was in use was under Margaret Thatcher, but even she did not face cuts of the scale that now face George Osborne. To maintain a triple A rating, Britain must cut £92 Billion (or roughly the annual NHS budget) over the next five years according to the credit rating agency Fitch, and Mr Osborne made it clear to MP’s yesterday that the role of the State is about to change significantly.

Social security payments, tax credits and public sector pensions are likely to bear the brunt of any cuts, which may end up being as high as 20 per cent. Mr Osborne cited the example of Canada, which faced similar difficulties to the UK in the 1990’s, but successfully turned a large budget deficit into surplus by strongly challenging ministerial spending decisions. What he failed to point out was the Canadian restructuring was achieved in a period of strong world growth with foreign demand able to replace government spending. We are certainly not in this situation now, and we are far from a consensus over whether current fiscal tightening will put Britain back on the long term path to growth or tip the economy back into recession. This uncertainty is reflected in the markets; Sterling is treading water in the run up to the Bank of England meeting tomorrow and the Emergency budget on the 22 of June.

The Euro broke the physiologically important 1.20 level against the Dollar on Monday and continues to trade weakly against all the major currencies. This morning there are reports that Spanish banks are having difficulty accessing funding in the European interbank markets, an ominous sign if true. The contagion from Eurozone members to periphery nations continues to spread with Hungarian Ministers stating their economy was left in a perilous state by the previous government, sparking significant price action in the Florint-Swiss pair. ECB head Jean-Claude Trichet speaks today ahead of the official policy meeting tomorrow and his words will be watched closely for any changes in stance or signals of the outcome of the meeting.

The Dollar continues to perform strongly as the safe haven currency, against Sterling we saw a slight rebound yesterday as Fed Chairman Ben Bernanke suggested the US economy was on track and had gained “a good bit of momentum” in consumer spending and investment. The US Stock market also finished yesterday in positive territory and with data from China showing export growth of 50% yoy, we may see a return to risk today and the corresponding move out of dollars and into riskier currencies.

Discuss on this on the Currency Exchange Forum