Yes, we know that last week's ECB ruling on base rates caused a much-needed weakening of the euro. But what else drove the spring's strengthening of sterling? Laura Parsons from Tor FX explains
In comparison with the turbulent market conditions experienced throughout 2012 and for much of 2013, the first quarter of 2014 was calm, with currencies like the Pound and the Euro experiencing fairly static trading.
While the Ukraine situation sparked a bout of risk aversion in March, and while it still remains a cause for concern, only emerging-market currencies like the Rand experienced any notable fallout from the stand-off with Russia.
So what factors have been driving currencies like the Pound, Euro and US Dollar, and how will they perform in the months ahead?
After rallying against its currency counterparts last year, thanks to a run of impressive UK data, Sterling’s upward momentum faltered in the first quarter. Because positive UK developments were largely priced into the market, and because the Bank of England revised its forward guidance policy to reduce speculation regarding the prospect of an interest-rate increase, the Pound headed into the second quarter trading in a narrow range against the Euro and US Dollar.
Yet the appeal of the Pound rose in April as UK employment figures revealed that the nation’s unemployment rate fell to 6.9% in the three-months to February – below the BoE’s 7% threshold. Although the BoE attempted to sever the tie it created between hiking borrowing costs and sub 7% unemployment, this result may encourage the central bank to revise fiscal policy in the near future. If the BoE hints at the prospect of increasing interest rates or reducing the level of asset purchases, Sterling could surge and could actually achieve yearly highs against its most traded counterparts.
Meanwhile, Over in Euroland
Meanwhile, as we expected, the Euro is also likely to be affected by central bank policy. While the Eurozone’s economic stability has improved dramatically since the dark summer of 2012, inflation concerns persist and the high Euro exchange rate has been an issue with policy makers. Signs of second-quarter deflation in the 18-nation currency bloc saw the ECB introducing additional stimulus. No surprises there, then.
And In the States?
Let’s turn now to the US Dollar. Although the North American currency has broadly strengthened since the Federal Reserve began reigning in stimulus in December of last year, the question of whether the central bank will leave interest rates at record lows for the medium-term has limited the Greenback’s allure.
US economic reports were patchy for the first three months of the year and the Fed will be waiting for data to show consistent improvement in housing, employment and consumer consumption before it makes policy less accommodative.
Over the next few months US Dollar gains could be triggered by positive US non-farm payrolls and domestic confidence reports. Conversely, if the knock-on effect of the unseasonably bad winter continues and US figures fail to impress, the US Dollar could retrace the advances made during 2014.
A Tumble for the Yen?
The Yen is another interesting case. As a safe-haven currency the Yen has advanced with every worrying development in the Ukraine and has also benefited from Chinese slowdown concerns.
However, the majority of economists are expecting that the Bank of Japan will introduce additional stimulus by June at the latest. After the BOJ launched an unprecedented run of easing in April 1023, the Yen had broadly softened, hitting historic lows against peers like the US Dollar. If the central bank does indeed add to the existing stimulus, the Yen may tumble as the second quarter comes to a close.
All in all, we could be in for a dramatic summer of currency-market movement. Other global economic factors will also be having an impact on foreign exchange trading in the months ahead, so keeping a keen eye on the latest developments is essential for any investors hoping to make a lucrative trade.