The currency blog

This morning the Office of Budget Responsibility delivers its first independent assessment of the outlook for the British economy and the budget deficit. This has some important ramifications for Sterling in the both the short and log run. We will get the first glimpse of whether the scorched earth legacy supposedly left by the previous Government is as bad the new Government has said it is – and a downbeat fiscal forecast would undoubtedly see a fall in the value of the Pound. However, the Chancellor would love to see the forecasts confirm the message he has been driving home, namely that to get the British economy back on the road to recovery, deep cuts to government spending are needed. Returning Britain to long term sustainable growth would see the Sterling rise towards it long run average levels against the Euro and Dollar (but it is far from clear if demand in the economy after the cuts are implemented will be able to support growth in the medium term)

The quarterly inflation report from the Bank of England also released this morning suggests the market expects interest rates to stay low for an extended period. Spencer Dale, chief economist at the Bank, highlighted the Eurozone fiscal crisis as the main concern over UK growth and said that Britain will continue to suffer the ill effects of the crisis even as the economic recovery continues. Mixed messages from the Bank however as Andrew Sentence, member of the MPC, raised the possibility of higher interest rates (due to far lower excess capacity in the economy than the bank originally thought and the higher inflation that this may produce). Sentence suggested rates may rise as early as the second half of the year. Sterling is performing strongly in early trading on the back of this news.

On Friday, currency markets continued to track the swings in global investor sentiment. European stocks extended earlier gains in the US and Asia. There was some market chatter arising from a press article that the EU was preparing to activate a rescue package in case Spain asked for it. However, Spanish-German bond spreads widened only slightly and EUR/USD easily held north of the 1.21 mark. Italy also succeeded in selling all of their planned €7bn of bonds. EUR/USD even tested the key 1.2150 area going into the publication of the US retail sales data which came out at a disappointing -1.2% month-on-month. However, even as the figure was a disappointment, the damage for equities and also for EUR/USD was limited. A better than expected Michigan consumer confidence release also eased the potential negative impact of the retail data.

This week the main data releases are UK CPI and claimant count data and also inflation figures from the US later in the week.

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