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Pride before the fall?

Well, we didn't quite get to the important 1.2200 level on Monday, and sure enough by the end of the week we were struggling to hold on to 1.2000, finishing at 1.2014.  This doesn't tell the whole story though, as things were looking good up until Friday, when the manufacturing output figures came out at down 0.4 instead of an expected rise.  The ONS (Office for National Statistics)  had forecast the figure to show a 0.5% rise for April and the drop suggests the economic recovery is struggling.  The decline was the first since January and shows us that the second quarter got off to a weak start after two consecutive quarters of post-recession expansion.

I have a nagging doubt that this sterling resurgence is not the one that is going to take us to the 1.2500 target.  Those of us who can afford to wait for it may well reap the benefit, but anyone in a hurry might well benefit from taking the levels we see now.  (Now watch it go up!)

Sterling rises

When equity markets rally, Sterling can benefit and strengthen, which is what we saw in the latter part of this week.  The pound fell earlier in the week after there were warnings about the UK's credit rating due to the deficit. This caused Sterling selling, bringing the rate down. It would seem though investors decided that this was overdone, and began to buy the pound once more, indicating that the bad news is perhaps already priced into the value of Sterling.

Just like the euro, the  pound is exposed to the risk appetite of international investors, and these investors are worried about the financial stability of both regions.  We may well not see a true pattern emerge until we see the extent to which the Conservatives mean business about correcting the deficit.

Bank of England hold rates

The base rate was kept  at 0.5%, and has now been there since March 2009. The bank uses interest rates to control inflation, usually raising rates. This in turn strengthens the currency due to the higher return. It's likely though that rates will remain this low probably until the end of the year, maybe even well into next.

However, last month a leading economic think tank warned that rates would have to rise to control inflation. The Organisation for Economic Co-operation and Development (OECD) called for the Bank of England to raise the cost of borrowing to 3.5% by the end of 2011.

When rates do start to rise, probably in 2011, it will likely provide some support for Sterling and provide a rally in rates. Unfortunately this is some way off. The ECB has held eurozone interest rates at a record low of 1% for the 10th month running, as expected. They also said growth would be patchy, but even this didn't hurt the Euro too much, as it is in such a parlous state anyway due to the debt problems in Greece and Spain.

What's next for the pound?

Most analysts are now saying that the markets are waiting for the budget on the 22nd of June. It will be fascinating to see what happens.  If  cuts and tax rises are more severe than expected because the debt is worse than expected, it could cause the pound to drop further.  If the same cuts and tax rises show a more determined effort to get things under control, the pound could actually rise.

Who would want to be a foreign exchange rate forecaster?

Little change this week, maybe just hanging on to the 1.2000 level.

a bientot,   Rob

Rob Hesketh and France Financial

Rob moved to France in 2003 after working for 30 years in International Banking in the City of London and Brussels.  He joined the Spectrum IFA Group in 2005 and became registered and authorised by the French fiscal authorities in mid 2006.  He is now a partner in Spectrum and looks after client relationships in the South West of France.

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