08/10/10

By Claire West

The pound slumped to a five-month low against the euro after a report showed UK house prices plunged by 3.6% last month - the biggest monthly drop on record. The Pound has since managed rally by just over 0.5% on news that the Bank of England have left interest rates at 0.5% and their Q.E. programme unchanged at £200bn . The poor house price data has added to speculation that the Bank of England may consider additional stimulus measures to support the economy as the government prepares the biggest public spending cuts since World War 2. The Pound traded as low as 1.1360, the same level we saw sterling hit after a hung parliament was confirmed back in May.

Andy Scott, foreign exchange dealer at foreign currency exchange specialists HiFX comments: “This apparent weakness in Sterling doesn’t tell the whole story though, as you have to look at the overall picture between different currencies. Many people have been surprised by the movement of Sterling against the Euro given the ongoing fiscal stresses affecting peripheral countries in Europe. Essentially the market is only concerned with one thing at the moment and that is central bank policy.”

With economic growth faltering, pressure is growing on central banks to take a pre-emptive approach to monetary policy to prevent their economies slipping back into recession. The most likely tool to be used would be quantitative easing, where central banks print money which they use to buy assets from the banks, increasing the money supply to stimulate lending. The Bank of Japan this week cut interest rates from 0.1% to a target of 0-0.1% and proposed a new fund to buy government bonds and other assets. In addition, the Federal Reserve seem to be moving towards a consensus on additional stimulus with several voters giving their support in favour of the measures this week. With the Bank of England also considering their options, one of the few majors currencies that doesn’t carry the ‘risk’ of central bank action is the Euro, which we’ve seen soar in recent weeks.

The Euro is at multi-month highs against the Dollar, Japanese Yen and the Pound. Few would have predicted this move with some of the major banks predicting the Euro would reach parity with the US Dollar as recently as May this year!

Scott continues “The momentum is certainly for a weaker Sterling and an attack on the lows of the year around the 1.10 level. However at the same time with GBP/EUR having dropped by nearly 7% in a month, this also needs to be seen as a favourable opportunity for Euro sellers”.