myriad international central bank meetings over the past two weeks have coloured currency markets leading up to the year-end. Several themes emerged from the meetings, namely, that we are not out of the woods yet, that interest rates will remain low for an 'extended period' and that moves are being made to exit economic stimulus. The first is applicable to the UK, the second to the US and the last to the eurozone, but broadly, the theme was repeated by the troika of central banks.
The good news for Irish exporters is that parity between the pound and euro is off the table before Christmas, which should help them retain some competitiveness. Last month's UK GDP data was a slap in the face for British economy and government alike and dragged its recession into a six-quarter slump. The Bank of England eventually extended the quantitative easing to £200bn, which was taken as a sign of another shot in the arm for the UK, at the expense of Gordon Brown's self-proclaimed 'saviour of the global economy' tag (and obviously the taxpayer!) This was largely priced into the pound and so it changed little against the euro, remaining around the £0.91 mark.
After the 'QE or not to QE' debate, a green shoot finally arrived in the UK. Quarterly data last week showed that unemployment stood at 7.8% at the end of September compared to 12.5% in Ireland and 10.2% in the US. This demonstrated a marked slowdown in the quarter from July to September. However, this green shoot turned out to be from Jack's Beanstalk as Bank of England governor Mervyn King took the microphone to discuss the bank's outlook for the UK economy last Wednesday. The Bank of England gave a courageous performance outlining how the UK would return to above-trend growth in late 2010 and reach 4% in 2011. Hmm, interesting. They effectively admitted defeat on battling the recession as lowering interest rates did not work, quantitative easing didn't work but the weak pound saved their skins. The last time King referred to the benefits of a weak pound it fell from £0.84 against the euro to £0.89. Watch out for similar moves in the coming months from the current level. The weak pound is the only dry powder left in the Bank of England's armoury, putting a stop to many Irish companies' wishes of a swift return to pound strength which would help boost their sales.
In the US, the Federal Reserve has indicated that interest rates will remain close to zero for an 'extended period' which is taken to mean that rates won't change for at least six months. However, the Fed spelt out one caveat: if inflation begins to tick upward, then rates will need to increase to prevent any further bubbles emerging. Unemployment data released two weeks ago pointed to a continuing rise, with the headline figure reaching 10.2%. In this case, inflation is unlikely to be a major issue and rates should remain on hold for most of 2010.
Investors are trying to make the most of the low cost of carry on the dollar, leading to worries over the carry trade. The dollar carry trade, where investors borrow cheap dollars to buy overseas investments with a higher yield, has boomed in the past six months or so and has drawn attention from the notorious Dr Doom, Nouriel Roubini, from the Stern School of Business in New York University. Roubini predicts that a failure in this carry trade when rates eventually do rise will lead to the mother of all bubble bursts, particularly in Asia, where cheap dollars are funding stock market and property bubbles.
So that brings us to the euro, the strong currency of the major currencies at present. Despite the eurozone's frayed edges (Ireland, Greece, Spain, Portugal), the ECB has actually put up a credible performance in dealing with the recession and credit crunch. Euro strength mostly stems from the fact that ECB interest rates are at elevated levels compared to the UK and the US, which will attract flows into the currency. ECB president Jean-Claude Trichet has room to manoeuvre by reducing interest rates if need be. However, it seems unlikely. The eurozone continues to churn out good news, with industrial production in the region, released last Thursday, showing a fifth consecutive month of gains.
The ECB is also the first of the central banks to at least walk the walk on exiting fiscal stimulus. It has made it clear that next month's unlimited emergency funds, scheduled for 6 December, would be the last and that the rate charged on these funds may also be higher than in previous offerings, which is likely to hamper demand. In June the ECB pumped €442bn in 12-month loans into the eurozone financial system at very low rates to stimulate bank lending to corporate and private customers. The ECB is expected to lift rates officially in September 2010, and to be the first of these three central banks to do so, which will also stimulate demand for the euro over the pound and dollar.
Euro strength emanating from these events means that Irish exporters, especially to the UK, are facing a turbulent time. The Irish Exporters' Association (IEA) has highlighted this issue, citing the euro strength against the pound in particular as causing "grave damage" to indigenous exporters. An army of Irish owner-managed businesses, especially in food and manufacturing, rely on exports to Northern Ireland and Britain as a first port of call when expanding to overseas markets and unfortunately they will bear the brunt of the strong euro. The IEA initial export figures to the UK show a drastic 23% decline on the same period last year.
Niall Haughey is a director of Blue FX Markets, the currency specialist