Foreign Exchange round-up

THE following was a letter sent from the foreign exchange company, International Foreign Exchange, to its customers to summarise recent measures taken to stem Sterling's demise against the Euro.

Markets continue to be volatile and unpredictable, and it’s a difficult patch for Euro buyers. Sterling has lost over 24% against the Euro in the last eight months and many large UK banks are forecasting it could get worse before things start to improve.
 
The course of recent events lead from the poor Halifax / Bank of Scotland house price index figure showing a -2.5% fall in prices in March – this was prior to your departure. This and other similar indicators at the time set alarm bells ringing at 10 Downing St. that the UK housing market could be about to fall into the same hole as in the US.
 
Though the Bank of England have reduced the base interest rate by half a percent, with two 25 basis point cuts – following losses incurred by the banks through sub-prime and the uncertainty around the UK’s housing and finance sectors, UK banks have been reluctant to lend approving only very low risk applications for credit. And of course it’s hard, if not impossible to get the property market moving again if the banks won’t lend, even with lower interest rates!
 
To alleviate the situation Alistair Darling last week announced a £50 billion package to increase liquidity in the mortgage market and thereby increase access to borrowers. This was seen as positive initially but market analysts were critical saying that the package would need to be doubled to £100 billion to have any real impact, and with this Sterling lost ground again.
 
However, in the last 24 hours expectations have built that the European Central Bank will be forced to cut interest rates in the coming months following a much weaker than expected German business survey. The IFO Research Institute said its April business climate index for Germany fell to 102.4 from 104.8 in March, well below analysts’ forecasts of a decline to 104.3. In recent months economists have been surprised at the strength of IFO surveys, providing support to the idea that the Euro zone economy has out witted the US and will weather the credit crunch relatively unscathed. However this data and also a weak manufacturing survey on Wednesday mean many analysts are now questioning this idea, boosting expectations the European Central Bank will be forced to cut interest rates.
 
"The IFO figures out of Germany this morning look very weak which would stem inflation concerns slightly and may give room for the ECB to cut rates," said Mills, a trader at TradIndex.com.
 
So this is the first sign of weakness in the Euro zone and initially at least has meant good things for Sterling which has climbed back over 1.27, currently trading on Interbank markets at 1.2724 (14:10 25/04). Earlier this week, Bank of England policymaker Andrew Sentance said that the Pound was likely to remain weak for some time and expectations of further interest rate cuts were driving Sterling lower.
 
All things considered, GBP/EUR is quite finely balanced. The next week or two will be interesting and data releases on both sides of the channel will be keenly watched. If data in Europe signals downturn Sterling could recover and push 1.30 or higher, however if as analysts predict the UK governments liquidity package is not enough to stem the tide of the UK housing crisis, prices will continue to fall and Sterling will weaken.