FX markets in holding pattern, awaiting the results of the all-important EU summit
24/Oct/2011 • Currency Updates•
Most currencies and asset markets ended the week not far from where they had started it, although high intraday volatility continued to be the norm across equity and commodity markets. All eyes remain on the outcome of the EU summit. Early in the week, markets were confident that a long-term solution to the European crisis would finally be agreed on this weekend, including an increase in the firepower of the European bailout facility via leveraging, a substantial recapitalization of European banks, and a reduction in the Greek debt burden to sustainable levels, including a haircut of 50% or more. However, a veritable cacophony of voices emerged mid-week out of the ECB, EU officials and European politicians making it clear that an agreement was still very far and another follow up meeting would be scheduled for October 26th. Investors remain unwilling to take aggressive positions until this uncertainty is cleared up, and the trade-weighted dollar ended the week almost exactly where it had begun.
The two key releases of the week in the UK pointed in opposite directions. First, the minutes of the latest meeting of the Bank of England Monetary Policy Committee (MPC) revealed that the vote to increase Gilt purchases had been unanimous. The entire MPC agreed that the significant softening of growth prospects justified such a step, and that the likelihood that inflation would fall significantly below target over the medium term had increased materially. No doubt MPC members were surprised (as we and the market were) by the stronger-than-expected inflation data for September. Headline inflation is now at 5.2% YoY, and core inflation also increased to 3.3% YoY. However, after stripping out the effects of the VAT increase and transport prices, inflation is considerably lower and has remained stable. We remain in agreement with the MPC that headline inflation has already peaked or will do so this month, and expect a fairly sharp drop once the VAT effects start dropping out of the index. Markets, however, gave more weight to the CPI numbers last week and Sterling rose 1% against both the dollar and the euro.
European officials followed the well-worn script of tantalizing the market with hopes for a decisive solution to the crisis early in the week, only to dash them midweek. Gaggles of leaking politicians and officials made it clear that France and Germany are nowhere near agreeing on either the size haircut for Greek bondholders (Germany wants more), leveraging of the EFSF facility (Germany is wary), or ECB participation on the bailout fund (Germany wants none of it). The agreement expected for this weekend EU summit was thus postponed to another meeting on Wednesday. Given the disastrous European response to the crisis, it is amazing that the Euro managed to end the week flat against the dollar, buoyed by a bounce in world equities and commodities.