The Bank of England is considering a reduction in the deposit rate to discourage banks from hoarding reserves. The Bank of England is of the opinion that such a move could help spread the benefits of quantitative easing to the broader economy. However, Mr King has noted that a similar move by Sweden’s Central Bank the Riksbank has only made a minimal impact.
Mr King stated that there were signs that the UK economy started to grow this quarter but the strength of the recovery is highly uncertain. He noted that the £175B policy of purchasing bonds known as quantitative easing was beginning to impact nominal spending and money supply but there is still a long way to go to get output back to previous levels, whilst risks to inflation remain on the downside.
Such comments make Sterling less attractive as global investors seek higher yields.
As mentioned previously, the future outlook for Sterling remains highly uncertain. The Pound should recover as the UK economy recovers from recession but the timing and strength of such a recovery is still unclear. With Germany, France and Japan already out of recession, confirmation that the UK economy is expanding again is vital to a recovery in Sterling. The market will also need to have some confidence that the UK will not slip back into recession, particularly as the government stimulus ends.
If Sterling interest rate differentials remain negative or even widen further then there is a risk that Sterling will remain weak for some time.
The European Central Bank (ECB) will meet today and at 12:45 they will announce the latest European Monetary Union (EMU) interest rate decision. As a result of the rapidly deteriorating economic data from the Euro zone it is largely expected that the ECB will cut interest rates by 0.50%.
This has had the effect of the Euro coming under downward pressure. This is a reflection of the sharp deterioration of economic conditions in the EMU. In particular we have seen unemployment rise sharply in the EMU. In Spain the unemployment rate is above 14% and in Ireland the rate has also climbed sharply to 11%. The average rate of unemployment in the Euro zone is now 8.5%. Even conditions in Europeâ€™s largest economy, Germany, are becoming particularly ugly as they struggle with a sharp decline in exports, not helped by the strength of the Euro!
It has long been argued by Currency Matters that the ECB is behind the curve especially when compared to the aggressive actions of the Bank of England and the Federal Reserve. As such, it will be particularly interesting to see if ECB President Trichet makes any comments in the following press conference at 13:30 pointing towards further cuts or the possible implementation of non-traditional monetary policy.
The ECB have been particularly cautious in their approach to monetary policy during the current downturn. However, I believe that the pressure on the ECB to act more aggressively is building.
I believe it is becoming increasingly apparent that the economic situation in the Euro zone, is not vastly better than the conditions we are seeing in the UK. As such, I am expecting the Euro to weaken over the coming weeks. The case for this will also be enhanced, as the interest rate differential advantage that the Euro currently holds decreases.