Euro Update

Sterling appreciates against the euro to levels last seen in December 2008. Sterling’s appreciation against the euro continued last week with a new 18-month high recorded at €1.2114, whilst a higher low was seen at €1.1715.

The main releases from the UK saw the publication of the Purchasing Managers Index (PMI) figures, which are leading indicators of economic health and seen as a good barometer of the sustainability of the current recovery in markets around the world. The UK’s Manufacturing PMI maintained a 15-year high reading of 58 (above 50 is expansionary, below is a sign of contraction in activity) despite a small fall being forecast. The construction sector also continued its recent resurgence with a reading of 58.5 (which was marginally above expectations), while the services number – the most important of the three – was slightly down on expectations, but still strong at 55.4. All of this lends further credibility to the UK recovery gathering pace.

Elsewhere, the pound also gained on news that UK house prices rose to the highest levels in more than two years. The Nationwide Building Society said the average cost of a home increased 0.5% in May to the highest level since July 2008. They maintain their view that the current supply and demand balance in the market is still consistent, with relatively stable to modestly increasing prices.

The other main news of the week was the collapse of the ambitious attempt by Prudential to buy AIG’s Asian arm. This prompted the unwinding of currency hedges put in place in anticipation of a deal, when the initial bid was announced back in March. AIG’s outright rejection of a reduced offer from The Pru’ put an end to the deal once and for all, with the UK insurer confirming that the deal was off on Wednesday. Sterling rose broadly on Tuesday as anticipation grew that the deal was close to collapse. The currency was still benefitting when the deal was finally taken off the table.

The euro has continued to struggle, as risk aversion at one point waned, resulting in renewed buying of riskier assets, including sterling. The recent downgrade of Spanish sovereign debt by credit ratings agency Fitch left the euro on the back foot due to ongoing structural weaknesses, particularly in the southern Mediterranean area of the eurozone.

Despite assurances from China and Kuwait that the euro’s current troubles would not affect their purchases of the single currency, rumours surfaced that Iran planned to sell some of its euro holdings as a result of the volatility. A Chinese news agency report that the Iranian central bank would sell €45bn of its foreign exchange reserves to buy dollars and gold further dented investors’ desire to hold the single currency. This adjustment to their reserve holdings was expected to be conducted in three stages, with the first tranche already underway. It was also claimed that other Gulf states had started to cut their euro holdings.

Data flows have had limited impact on the single currency in recent weeks and the same was true this time around. German retail sales and employment figures were better than forecast, whereas the Europe-wide unemployment rate remained constant. European retail sales were down 1.2% against the forecast of a small rise and revised GDP was unchanged at 0.2%. As mentioned above, this had almost no effect on the euro, with investors preoccupied with more serious matters. However, the data is not supportive of a broad-based recovery in Europe, which will be of concern to those nations about to embark on significant spending cuts that will only hinder growth further. A more specific indicator of future growth rates was the composite European version of the Purchasing Managers Index (PMI). This showed a fall to 56.4 from 57.3 in April – although this was still above an estimated 56.2. The service sector component rose to 56.2 from 55.6, whereas the manufacturing figure declined to 55.8 from 57.6. The outlook for the region’s economy has darkened in recent months, as the threat of contagion from Greece’s fiscal crisis raises investors’ concern about the future of the euro area. While the problem has pushed the euro lower this year, making exports more competitive, governments have had to respond with tougher austerity measures to cut budget deficits. This, in turn, has dampened consumer confidence.

Further alarming news from the eurozone came from an eastern European member state. Last week saw Hungary’s new Prime Minister, Viktor Orban reveal that his nation’s finances were in a “very grave situation” and that his predecessor had falsified the true state of his country’s finances.

Whilst Hungary is not the biggest economic power in the world, this news will further undermine confidence in the eurozone due to the lengthening list of nations that may need to seek emergency funding from the European Central Bank (ECB) in the future.

With worsening economic conditions gripping the southern Mediterranean countries, we are already seeing great levels for euro buyers to hedge all or part of their exposure. Whether for a one-off real estate purchase or ongoing living costs, they would be wise to fix a price for half the amount of currency they are going to need. Hedging does not guarantee buying euros at the best possible price; it guarantees not buying them at the worst.

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Tags: Currency recovery market, Current market, Euro, Sterling

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