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Friday November 14, 2008 - 15:53:12 GMT
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FX Briefing - Pound nears all-time lows

FX Briefing 14 November 2008

·        Highlights

·        Enthusiasm for Chinese stimulus package only short-lived

·        “Troubled Assets Relief Program”: re-designated

·        Bank of England sees deflationary risks, announces further interest rate cuts

·        Germany and eurozone are in a recession

·        Australian central bank intervenes in forex market to support AUD


Pound nears all-time lows

Financial markets cheered up initially at the beginning of the week after the announcement that

China was launching a fiscal stimulus package and would spend the gigantic sum of Rmb

4,000bn (about €460bn) over the next two years in order to boost the economy. Stock markets and commodities started the week on a firm footing. The reaction in the forex markets followed its now familiar pattern: when fear subsides, the US dollar gains against the yen, but at the same time loses ground against most other currencies. Thus, at the beginning of the week, USD-JPY rose over 99, and EUR-USD climbed to 1.29. However, the upbeat mood over the Chinese package did not last very long. This was partly because even a fiscal stimulus equivalent to about 7% of Chinese GDP per annum is relatively modest on a global scale, but also because a large proportion of the expenditure was thought to be normal rather than extra spending, or already in the pipeline, like reconstruction aid for the earthquake region.


As early as Tuesday, equity prices started to crumble again. One reason for this was US Treasury Secretary Henry Paulson’s announcement that the government would not purchase toxic assets from banks after all. Originally, this had been the main idea behind the $700bn “Troubled Assets Relief Program”, but had been shelved in favour of capital injections for banks and funds for AIG. Now Mr Paulson wants to completely re-designate the second half of the $700bn rescue package and use it to support consumer lending. Another reason was the Bank of England’s extremely bleak picture of UK growth prospects. The BoE estimates that the UK economy will shrink for a further three to four quarters. Against this backdrop, the central bank is expecting inflation to slow down rapidly to below 1%. With this inflation forecast, the bank is in fact signaling that it is prepared to make more aggressive interest rate cuts to combat the looming threat of deflation. Governor Mervyn King stated that the central bank would cut rates as much as was necessary to achieve the inflation target of 2%.


This announcement plus poor UK labour market figures put the pound under massive pressure; cable plummeted below 1.46 temporarily. Towards the end of the week, things brightened up a bit, but at around 1.48, the pound has still lost about 5% against the dollar this week. At below 1.50, cable is now nearing its lows of 1992-1993 and 2000-2001. EUR-GBP rose from 0.81 to

over 0.85 – a new record high since the introduction of the euro in 1999. For those who still remember D-Mark times: the present level is the equivalent of GBP-DEM 2.29; that is significantly lower than after the pound had been expelled from the EMS, but above its all-time low of just under 2.17 in 1995.


Towards the middle of the week, EUR-USD was dragged down by the weak equity markets and the bad news from the UK. It came under even more pressure after it was announced that real GDP in Germany had fallen by 0.5% qoq (more than expected) in the third quarter. As GDP had already declined by 0.4% (revised) in Q2, according to the two-quarter rule, Germany is now in a recession. In this environment, EUR-USD slipped to below 1.24 at times. However, as equity markets firmed, the euro recovered and is now trading at around 1.27, only slightly below its level at the end of last week. The news that eurozone GDP had “only” fallen by 0.2% (mainly due to the unexpectedly good French results) also brought some respite.


On Thursday, it transpired that the Reserve Bank of Australia had become the first major central bank to intervene in the currency market in this volatile period. The RBA gave the reason for this as lack of liquidity in the forex market; it is obviously noticing that exchange rate movements are increasing due to market participants’ heightened risk aversion.


The RBA’s move could perhaps be the first indication that central banks are becoming less tolerant of hefty exchange rate swings; the burdens on the economy are big enough as it is, even without extreme exchange rate swings on the forex market. Japan, for instance, seems to have become somewhat more “thin-skinned” recently. Here there is the problem that export earnings are being cornered on two sides simultaneously, on the quantity side and on the exchange rate side. We would therefore not be surprised if currency authorities started focusing more on the question of liquidity in forex markets and stabilising exchange rates, possibly at the G20 meeting too.


Stephan Rieke +49 69 718-4114

Economics Department

+49 69 718-3642

[email protected]

Foreign Exchange Trading

[email protected]

Jörg Isselmann

+49 69 718-2695

Matthias Grabbe / Klaus Näfken

+49 69 718-2688


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