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Yesterday, I reported that Central Banks are becoming more transparent in matters of monetary policy. As if on cue, today the European Central Bank and Bank of England offered separate insight into the directions of their respective interest rates. The ECB hinted that it would likely raise interest rates twice in the next year from the current level of 2.25%, while the Bank of England indicated that a cut in its interest rates would take place in March. The corresponding changes in interest rate differentials should benefit the Euro and hurt the British Pound. Reuters reports:
But some analysts see U.S. rate rises stopping there. The latest report about the ECB is seen as likely to boost the euro. “It’s a reminder that not only the Fed but also the ECB is raising interest rates,” said one currency strategist.
The US Federal Reserve Bank is currently in the process of raising interest rates. Meanwhile, the European Central Bank and Bank of Japan are preparing to begin implementing tighter monetary policies at unknown dates in the short term. The Bank of England, however, is moving in the opposite direction, having recently announced that it may cut rates in the first half of 2006. The Bank of England is caught in the unenviable position of trying to simultaneously manage a housing bubble, rising inflation, and slowing growth. Previously, Britain’s Central Bank had prioritized housing and price stability. This latest announcement, however, represents a change in tack. As investors price in the possibility of multiple rate hikes, the UK Sterling should add to its 6% decline against the USD so far this year. Bloomberg News reports:
“The market was always complacent about the performance of the U.K. economy,” said a currency strategist at Royal Bank of Scotland. “Comments…play into the hands of a bad performance for sterling against the dollar next year.”
In a recent report, Britain’s Central Bank warned that the nation’s economy would likely grow at a pace of 1.75% in 2005, which would represent the worst year of growth in over a decade. This latest forecast is significantly from earlier forecasts of 3-3.5%, that the Central Bank had released earlier this year. According to experts, rising energy prices are responsible. Others pin the blame squarely on the slowing real estate market, which has spurred a sharp decline in the consumption component of GDP. Ironically, other G7 countries, including Germany and Japan, are finally showing signs of growth. Britain’s economy, however, seems headed in the opposite direction. The Wall Street Journal reports:
Calling 2005 “the toughest and most challenging” of his eight years as treasury chief, Gordon Brown blamed “a virtual doubling of global oil and commodity prices.”
Last week, the UK Central Bank voted to lower interest rates for the first time in two years, to 4.5%. Economists and analysts are already mooting the possibility of another decline before year-end, in anticipation of lower-than-expected UK economic growth. Several UK policy makers, however, are reluctant to lower rates any further, lest they incite another housing bubble. Rising home prices have already fuelled excessive borrowing and a proportionate rise in consumer spending. Officials, however, are worried that these spending levels have reached dangerous levels, rising twice as fast as wage growth statistics would seem to imply. The upshot is a very low likelihood of continued rate cuts. The Economist reports:
It is unlikely that Britons are in for a series of interest-rate cuts. The Bank of England knows that no good will come of re-inflating the housing bubble, which would only result in worse pain down the road, as more consumers fall into the trap of too much debt.
Britain recently became the first developed country in two years to lower interest rates, guiding its repo rate downward to 4.5%. However, representatives from the Central Bank effectively dismissed speculation that other rate cuts would follow, calling the move “economic fine-tuning.” They will continue to target inflation, which is likely to resurface once Britain’s economy resumes its expansion. Many analysts believe policy-makers in other developed regions will soon follow suit, ushering in a period of tight monetary policy. Those analysts may be forced to wait, however. The Financial Times reports:
The European Central Bank maintained its main interest rate at 2 per cent. Recently, evidence from business surveys appeared to back its view that conditions in the eurozone were improving.
The release of the minutes of last month’s meeting of Britain’s Central Bank revealed a growing minority of members in favor of lowering interest rates. The official vote was 5-4 in favor of maintaining interest rates at current levels. However, few economists and pundits had reason to believe the vote would be so close. While many traders had already begun to price lower interest rates into bonds prior to last month’s meeting, it seems a rate cut at the next meeting is a near certainty. Recent economic data not only suggests the economy is slowing down, but also that inflation is likely to be lower than expected. As a result, both the members of the Central Bank targeting inflation indices as well as those targeting general economic performance, would seem to have a solid basis for lowering rates. The Financial Times reports:
Sterling had already been on the ropes prior to the MPC announcement…Against this backdrop sterling fell to a 19-month low in trade-weighted terms.
At its last meeting, Britain’s Central Bank voted to leave the national interest rate unchanged at 4.75%. With new data pouring in every day suggesting Britain’s economy is in trouble, the Bank’s leaders may soon rethink their stance on interest rates.