Currency market volatility continues

Published by Rhian Nicholson on 26 May 2010.
Last updated on 26 May 2010

currency on chart

The volatile currency markets have certainly been buzzing in recent weeks - and there's plenty more adrenaline to come.

Despite the euro's temporary bounce on speculation that European Union finance ministers meeting will discuss ways to control the debt diaspora, many city commentators remain highly sceptical about the euro's prospects.

They have blamed its fall on politicians for being slow to react to the unfolding crisis.

Mark O'Sullivan of Currencies Direct says the euro has been hit by the market's loss of confidence in politicians' abilities to bring in the austerity measures needed.

Some big players remain unconcerned, though. Eurozone finance chief Jean-Claude Juncker says he does not see why European policymakers should act immediately to stop the euro's recent declines.

The euro has found itself firmly out of favour with investors amid fears that European leaders are not fully supportive of last week's €1 trillion bail-out.

Germany's decision to go it alone with the ban on naked short selling on certain financial stocks and credit-default swaps also did the euro few favours.

Economists said the measure smacked of desperation and turns the spotlight on the fact that Europe is unable to pull together to address its debt crisis.

Although it remains uncertain if other countries will follow suit with their own shorting bans, the possibility of similar moves helped shove the struggling euro to a four-year low against the dollar.

Couple this with concerns that waves of debt contagion could soon flood into other countries whose public finances could do with a bit of toning, and it's going to take more than political polyfiller to repair the damage.

Stuart Thomson, chief economist at Ignis Asset Management, believes the euro should see some temporary respite in the next couple of weeks but the longer-term picture doesn't look good.

He says the immediate liquidity threat to the euro has been addressed by the €110 billion package for Greece and the €750 billion of loan guarantees for other eurozone countries which run into financial problems - even if the markets are being slow to acknowledge this.

Weak prospects

However, Thomson believes the euro's prospects are much weaker over the long term. He expects the euro to continue falling over the medium term and reach parity with the dollar by the end of 2011.

Peter Lees, head of UK equities at F&C Asset Management, takes a far more sombre line.

"The bail-out for the peripheral countries in the Eurozone will only buy time and the authorities have not addressed the central problem of how to reduce debt. In my opinion, the end result is likely to be default or debt restructuring combined with fundamental reform of the Eurozone, that may or may not involve fiscal as well as monetary union," he says.

Meanwhile the UK is risking the wrath of its euro buddies in its determination to steer well clear of the troubled single currency.

Unlike the 16 eurozone members, it has refused to sign up to its rather massive €500 billion bail-out. Prime minister David Cameron claims that while it is in the UK's interest to be supportive of the euro, this does not stretch to financial aid.

"It is in Britain's interests that the eurozone is a success, that the euro is a successful currency, that the eurozone economies recover, that the structural imbalances and structures are addressed, that those eurozone members that have problems are helped," he says.

"It is in our interests that those things happen, 60% of our trade is with Europe. Obviously as we are outside the eurozone, it is not the same call on us in terms of financial support - it shouldn't be because we are not members of the euro.

"But certainly we should work together with countries that are in the eurozone to ensure that that stability, that progress, the deficit reduction and other things are there."

The pound plunges

While all eyes have been on the euro of late, sterling has found itself in limbo, dropping to 13 month lows against the dollar, which investors have fled to as a safe haven.

Alistair Cotton of foreign exchange service Currencies Direct says: "Sterling sentiment remains weak, so expect the pound to come under further pressure as risk is taken further off the table."

Investors are waiting on news from the emergency Budget on 22 June as sterling is in a bit of a catch-22 situation at the moment.

While sentiment towards the pound is likely to improve following the announcement of any firm plans to cut the deficit, Duncan Higgins, senior currency analyst at foreign exchange service Caxton FX, says it's near term direction will depend on exactly where the spending cuts fall.

"There are growing fears that imminent fiscal tightening may derail what is only a fragile economic recovery. Nonetheless we expect that firm plans to address the deficit will improve sentiment toward sterling," he says.

Still, Lees of F&C says the forthcoming austerity measures are likely to depress growth. This will increase the risk of a double dip recession and weigh on sterling.

With the currency market likely to remain in a state of flux for weeks to come, traders could well need nerves of reinforced steel. 

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