Sterling’s difficulties continued throughout February as speculation and rumour of a UK credit rating downgrade were finally validated, writes Ben Scott.

The downgrading by Moodys resulted in a 16 -month low against the Euro of €1.1343 (interbank), as illustrated by Point C on the graph below.

Sterling started February in extremely negative fashion suffering the largest one day drop against the Euro for almost three years falling 1.8% as shown by Point A on the graph.

However during a very volatile month rates reached highs of €1.1817 (interbank) on 10th February before re-establishing declines, trading at an average rate of just under €1.16 (interbank) during February 2013.

Unlike January, sentiment alone failed to support the Euro as deteriorating economic figures and growing political uncertainty saw it decline against most currencies, except Sterling.

However, Sterling's decline of over 8% against the Euro in 2013 continues to cause great concern amongst Euro buyers.

The incline in the GBP/EUR rate leading to Point B on the graph came as political upheaval in the Eurozone led to concerns that the European debt crisis may be reignited, leaving investors to question the validity of recent Euro strength.

A combination of better than expected manufacturing, industrial production and service sector figures all indicating growth provided much needed respite for the disliked Pound as hopes grew that the UK would avoid a credibility damaging triple dip recession, with the Confederation of British Industry (CBI) claiming the UK economy would grow 0.3% in the first quarter of 2013.

The continual decline of Sterling against the Euro from Point B on the graph came despite a barrage of negative economic data releases from the Eurozone demonstrating that the current Eurozone recession is likely to be longer and deeper than originally anticipated.

Sterling’s weakness in this period can be attributed largely to growing evidence that the Bank of England is content with the recent weakness, and see it as a means of boosting overseas demand for UK exports thus improving the potential for economic growth.

In a blatant admission that a cheaper Pound is acceptable the Bank of England Governor, Mervyn King, stated that a lower exchange rate “would be necessary to redress Britain’s substantial external imbalance.”

Sterling weakness was compounded on February 20th when minutes from the Bank of England’s Monetary Policy Committee meeting showed growing support for additional Quantitative Easing in the UK which would have the effect of devaluing Sterling further.

Outlook

Numerous factors will determine the future direction of GBP/EUR exchange rates in the short to medium-term.

However, the continued concerns about the UK economy, its sluggish growth outlook for 2013, and Moody’s credit rating downgrade, shows not only a lack of confidence in the country's ability to establish any sustainable economic recovery.

It also represents a damning indictment of the UK Government’s economic and austerity policies, with the UK set to borrow in excess of £10 billion more than initially forecast this year alone.

French Prime Minister Francois Holland has suggested that intervention is required to devalue the Euro. However European leaders, including European Central Bank President Mario Draghi, have been keen to distance themselves from potential currency manipulation suggests current levels against Sterling can be sustained.

In the short-term, despite the markets’ attempts to downplay the ability of the Italian election result to derail any potential recovery in the Eurozone deadlock, or even worse, a success for Silvio Berlusconi and his anti-austerity government, the result could prove disastrous for the Euro.

Ben Scott
Foreign Exchange Ltd
www.fcexchange.co.uk