By James Hickman, Managing Director, Caxton FX
What a year 2011 has been: the uprisings in the Arab world, earthquakes in Japan and New Zealand and not to mention the deaths of three dictators, the Royal Wedding and the London riots.
In terms of the financial environment, if we look back to the end of 2010 we were still waiting for conditions to improve for the global economic recovery and as we approach the end of 2011, we still cannot see the wood for the trees.
2011 was meant to be a year where we took bigger steps towards the goal of economic improvement but in my mind, there have been two key factors which have prevented this from happening.
Firstly, there has been a top-down liquidity squeeze which has had a significant impact on everyone from countries and large banks right down to individuals and small businesses.
In short, no-one can easily borrow money and as we all know, accessing affordable loans is key to a vibrant and growing economy, whether you are the government or a small shop keeper.
What this has resulted in at the top end — which is the really worrying part — is that some countries have been unable to repay existing loans and debts. Consequently, some loans have been written off causing share values to plummet and the very real situation of some of those countries staring default in the face.
The second key factor in the global economic recovery, or lack of it, has been the financial mess within the eurozone.
The European Central Bank (ECB), working alongside the central banks of the 17-member states of the eurozone, have been too slow to react to the debt crisis over 2011 and have constantly been playing catch-up, despite several crucial summits over the year.
This has seen the markets respond negatively towards this inertia and subsequent bailouts have required strict austerity measures, which as we have seen in the UK, are not looked on in a favourable light by the local populous, as well as being hard to implement.
The knock-on effect of this has seen the euro, which has been pretty strong since 2007, depreciate against most major currencies since the summer. While a cheaper currency is a good thing for exporters, importers looking to bring in goods from economies linked to stronger performing currencies, such as the USA and UK, will find it tough to buy goods and services when the dollar and sterling are performing so well.
So what’s in store for 2012? Unfortunately doom and gloom still holds centre court and we predict that the issues that we have talked about so far will continue to rear their ugly heads well into 2012.
There is a strong possibility that the euro will continue to weaken well into Q1 and Q2 and we might also see some of the periphery eurozone states start to drop out of the single currency.
If I were a betting man, Greece would be a good shout for being the first to drop out of the single currency as they will find it hard to stick to the ECB’s fiscal measures which are proving deeply unpopular at home.
Greece’s departure could also cause a domino effect with other weak eurozone states also dropping out of the single currency.
But I think it’s incredibly important to note that we don’t see the euro completely collapsing any time soon — so there’s no need to panic. There appears to be the political will to keep the single currency project alive and with weaker countries dropping out, the remaining countries will see a reverse in fortunes and could actually see the euro strengthen again.
Closer to home, we see sterling maintaining its current position as being one of the stronger currencies. While a strong pound is an advantage for importers, taking advantage of being able to bring in cheaper goods, it will be expensive to export British goods - especially to the eurozone — which raises further concerns about the UK’s trade deficit.
Considering our high debt levels and the fact that everyone wants to see a weaker pound, we might see further Bank of England (BoE) intervention to try and weaken sterling, as well keeping interest rates at a record low of 0.5%.
Another question at the front of peoples’ minds is whether we will experience a recession in 2012. While the markets have responded warmly to the Government’s austerity measures and growth is flat rather than negative, all of this will be blown out of the water if there is a recession in the eurozone, an event which is more than likely.
The eurozone is our most important trading partner and if there is recession on the continent, this will interrupt trade flows and hinder the amount of business UK companies can carry out.
Nonetheless, if we do see the weaker eurozone nations drop out, the consequences will be only felt by the UK in the short-term and we will eventually see a balancing act where the eurozone will regain its strength.
In terms of currency and considering that our outlook for both the global economy and the eurozone debt crisis is negative, as a final thought, we see the euro losing ground against both the dollar and sterling in 2012. Additionally, the dollar should outperform the pound in risk averse circumstances next year and maintain its position as a safe-haven currency.
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