Currency market updates - from Foreign Currency Direct (www.currencies.co.uk)

Tuesday September 25th 2007

By Tom Arnold - Senior Executive Dealer

Monday’s Trading

Sterling recovered from a one-year trough against a basket of currencies on Monday, as investors started the week feeling a bit more optimistic about the health of the UK economy.

The Pound had lost a great deal of ground in the last week, after news that UK bank Northern Rock had fallen victim to the worldwide credit market squeeze, sparked by defaults on U.S. sub-prime mortgages. This had led to worries that Britain’s traditionally strong banking sector, is more exposed to the problems than expected.

Coupled with signs of a slowdown in the housing market and recent inflation releases being low, this convinced investors that UK interest rates have peaked and many are now forecasting at least one cut in the coming months.

To seemingly make matters worse, there are more cases of Foot and Mouth being announced daily, together with news that the Bluetongue Virus is also ravaging UK livestocks. Remember the last time there was a mass country-wide outbreak it cost the UK economy £6.0 Billion.

Nonetheless, the UK economy has held up reasonably well. Queues of savers outside Northern Rock branches have dispersed since the government guaranteed all deposits and money markets seem to be stabilising with London Inter-Bank Offered Rates (Libor) for three month Sterling deposits, fixing at a 6 week low on Monday.

These factors helped the Pound recover some lost ground on Monday, though analysts said fresh losses could be round the corner.

"Maybe people are a little bit more confident about the economic outlook and perhaps also that liquidity problems in the financial markets may be abating a little bit," said Paul Robson, currency strategist at RBS Global Banking.

"Sterling sold off quite aggressively last week on the back of worries about Northern Rock and banking sector liquidity. There is still a long way to go for this story to play out, but very short-term, Sterling is just recovering a little bit."
The Euro lost 0.2% against Sterling after hitting a 1.5 year peak on Friday, but was still on track for its biggest monthly gain in percentage terms, in 4.5 years.

In contrast to Britain, Eurozone policy makers remain hawkish. With suggestions they may consider interest rate hikes later in the year, once calm returns to financial markets.

The only negative in the Eurozone, was an attack by the ECB chief, Jean-Claude Trichet, on France. He warned that France, in comparison to its GDP, is outspending all of its neighbours in 2007. France’s prime minister also confirmed that the country’s finances were in a critical state, although he blamed the ECB for its policies! Newly elected President Sarkozy has vowed to reign in spending, to ease the deficit in the economy by 2012.

The US on the other hand is still struggling. With the sub-prime mortgage situation still gripping the country, and an interest rate cut already in place, the US Dollar has nowhere to turn for any strength. The Euro is enjoying unprecedented highs against the Dollar and even a weak Sterling has continued to gain against the Greenback!

With very little data of any note due out, the focus will be on UK house price and consumer confidence data for September, towards the end of the week. Any more news on the health of the banking sector will also be keenly watched.