Why has Sterling fallen against the Euro?
Sterling fell broadly on Tuesday, as fears of a nuclear crisis in Japan sparked a global pullback in riskier currencies and led investors to pare expectations of an early rate hike by the Bank of England. In contrast, markets expect the EU to raise rates sooner than the UK, and these are the main reasons the pound has fallen against the Euro.
With the budget coming in the next few weeks and expectations of further cuts, it could be that Sterling remains weak while the Eurozone gathers pace. For this reason in the short to medium term GBP/EUR rates are likely to remain volatile.
Will GBP/EUR rates recover?
Eventually, yes. Once the recovery in the UK has a sure footing, and interest rate expectations are clearer. In the medium to long term markets expect GBP/EUR rates to recover back to €1.20 / €1.25 within 12 months. However due to the volatility in the markets, in the next 3 months rates could well get worse before they get better.
What is the effect of the Japanese Tsunami on the currency markets?
Markets hate uncertainty. There is much uncertainty in the world at the moment with both the Tsunami and Earthquake rocking the markets, in addition to continued unrest in Libya and Bahrain.
Due to this uncertainty investors are pulling away from riskier currencies of which Sterling is one. That's why rates and stock markets have fallen across the board over the last few days. The Bank of Japan has pumped another $43bn into the markets today to try and ease investors fears.
Why is the Yen (JPY) getting stronger when you would think it should weaken?
I've been asked this several times over the last few days. Logic would dictate that due to the tragic events the Yen should be weakening and GBP/JPY rates would climb. The opposite has been the case and the Yen has actually strengthened.
It's a combination of factors, but the main one is carry trades. This is where an investor would borrow funds in a currency with very low interest rates such as the Yen, and re-invest this is in a currency with a higher interest rate, such as the Aussie Dollar.
With market uncertainty meaning investors are pulling away from risky investments, these carry trades are being unwound. This means they need to buy back the Yen to repay the loan, and it's this demand for Yen that is causing the strength. $4tn is traded in the currency markets every day, and the majority is by speculators with many opting for the carry trade.
Today's Data
Today we have UK unemployment and earnings data. From the EU various inflationary measures are released which could support the cause for a rate hike and push GBP/EUR down. UK also releases inflation data today although rates stateside are likely to remain on hold for some months to come.