By Chris Towner, Director of FX Advisory Services at HiFX

Sterling remains undervalued and despite all the uproar from the austerity measures, a tough approach to reducing the debt with stable politics is the only way forward and if there is a recovery then Sterling is well poised to take advantage of this.

FX is a ratio market and by this we mean comparing one country against another. You can often get caught up in the bleak outlook for the UK economy with its borrowing problem and slowing growth; however what needs to be pointed out is that this is being resonated throughout the world.

The UK was one of the first countries to address the debt problem with austerity measures helped by the new coalition Government and with a competitive and flexible currency; the UK is well placed to weather the storm despite the difficult conditions that we find ourselves living in. Also the Diamond Jubilee and the Olympics will make the UK an attraction and give a much needed boost to confidence.

2012 will see a much needed drop in the inflation rate as the higher commodity and transport costs of 2011 roll out; however the consumer just like the country is experiencing a culture change from a ‘buy now, pay tomorrow’ culture to a hybrid version of ‘save now to buy tomorrow’. This enforced culture change needs to be tolerated and will help steer the UK back from the abyss of its borrowing problem and will avert us from the more concerning route of a full blown debt problem.

The one thing to watch out for going into 2012 is the bond market and the Government’s borrowing costs. At the moment there is festive cheer as we can take full advantage of our AAA credit rating and low borrowing costs. The risk is that the bond market takes this away from us and the UK needs to continue along its path of reducing borrowing to avoid this full blown debt problem like other countries have experienced in 2011.

GBP/EUR to head higher to 1.2500 into 2012.

Predictions for the eurozone

Despite Europe having long term issues, the fears of the eurozone breaking up are what drove the fear in the financial markets throughout 2011. Needless to say the thought of the Euro breaking up is too scary a thought and it is for this reason that we will still see the Euro into 2012 and beyond. Merkel has played a steady hand throughout and once ‘the fiscal compact’ is in place, the EFSF and ultimately the ECB as the lender of last resort will prove enough to allow stability to return. Saying that though the Euro itself is over-valued and austerity in Europe will bite into growth and so the outlook for 2012 is for a clear downward trend with stints of euphoric bounces!

Predictions for Germany

The question is often asked what would the eurozone do without the Germans. With the unemployment rate at two decade lows at 6.9% fortress Germany appears to not only be weathering the sovereign debt storm but thriving from it too. The German population has always been cautious with debt and the housing market model is not based on an asset price bubble with a lot higher rental sector than in the UK. It is this steady ship which will be able to guide the EU forward; however the outlook remains tougher than the last two decades.

Predictions for Japan

Japan has an enormous debt pile of over 200% to GDP and growing rapidly, an ageing population and yet in a sovereign debt crisis is seen as the ultimate safe haven! This is because the vast majority of demand for their bonds is internal demand and therefore they fund their own debt. Therefore Japan can carry on for now along the self destructing path to the cliff’s edge, but with no clear alternative path at some stage the population will wake up, just like Europe did, and lose confidence in funding this debt pile. If Japan ever needs to rely on foreign money to finance its debt then its cost will soar. Without its home comfort blanket, Japan would be caught very exposed. With the Bank of Japan intervening aggressively and the Japanese yen in over-valued territory, this currency is expected to weaken into 2012.

Predictions for China

Over the last few years China has proved to be an engine for growth managing to counter-balance some of the severe recessionary shocks we have seen in the Western world. However similar to Japan in the late 80’s, there are gradual signs that the incredible double-digit growth that we have witnessed is starting to show cracks. In November the manufacturing sector in China contracted as China starts to fill the economic chill from the eurozone. On top of this there are some worrying signs that the house price bubble is coming across gravitational forces and this will have a serious impact on confidence levels as the Chinese population has become accustomed to a housing market that continues to return higher asset prices. Sound familiar to the UK going into 2008?

As we close off 2011 and enter 2012 China faces risks of slowing growth, perhaps 8.0 to 8.5% GDP compared to 10%+ and lower interest rates to stimulate a flagging housing market. We have seen China’s trading partners already cut rates, for example Australia who recently cut rates by another 25bps to 4.25% in order to try and accommodate slowing growth. No country in this global world is immune to the sovereign debt crisis in the EU and perhaps we will see China take the brunt of the safe haven status that the Central banks of Switzerland and Japan have been combating by allowing the renmimbi to have more flexibility and strengthen at a faster pace. USD/CNY to test the psychological 6.00 level by the end of 2012 is now on the cards.

Predictions for current safe havens

The interesting thing about the typical safe havens in 2011 is that they became too volatile to be considered safe havens! Interestingly going into 2012 perhaps corporate bonds for a steady large multi-national may be seen as a safe haven away from the sovereign debt!

Predictions for the US

The US dollar has benefitted from its status as a liquid haven when everything goes pear shaped. If we do see some form of stabilisation into 2012 we may see this currency resume its weakening trend especially as this is supposed to be a tough ride into the next election.

Curve ball prediction

2011 has proved a volatile year as economics and politics have rubbed up against each other making currency markets even harder to forecasts. Saying that though there is a currency that could be a hot pick for 2012 and that is the Turkish lire. This needs to be taken carefully as the Turkish lire is indeed a very volatile currency and has weakened consistently over the last four years from lows at 1.15 against the US dollar to 1.85+ currently. The economy has a perfect logistical position, the population is young and therefore can afford the burden of the older generation. It has strong growth, a stable banking sector and good healthy proportions of GDP make-up with a balance of agriculture, industry and service. Although risky, if 2012 brings some stabilisation then Turkey is well positioned to benefit.

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