Friday, 21 October 2016

Contrasting UK and EU economies

Super Mario causes brief dip in GBP/EUR rates 


Yesterday the European Central Bank (ECB) kept their interest rates on hold and their stimulus programme unchanged, but comments in the press conference afterwards caused a brief strengthening of the single currency. There had been rumours that the ECB would start to taper their Quantitative Easing (QE) programme from March, however ECB President Mario Draghi said policymakers had neither discussed extending the ECB's extensive bond-buying programme, nor ending it.

This sent the Euro higher, and briefly caused GBP/EUR to dip by 1%. He then added however that there would not be an abrupt end to the stimulus, hinting that they could extend the programme beyond the March 2017 deadline. This weakened the Euro again putting the GBP/EUR pair back to where it started, just above €1.12 level. In December, the ECB will discuss when and how to end the stimulus programme, so watch this space.

Contrasting economies 


There’s a good chance they will extend the programme further, given the state of the EU economy. France and Italy showed no growth at all in the last quarter. Spanish, Italian and Greek youth unemployment is around 50% (!) and Germany is starting to slow. In terms of stimulus it’s hard to know how much more of a following wind the EU could have; austerity has almost ended, interest rates slashed, a flood of printed cash from Mario, and yet the economy fails to recover. The ECB’s first chief economist and architect of the Euro said this week that it is a house of cards that will inevitably collapse, due to the system being compromised by bailing out bankrupt states in violation of the treaties. 18 years ago, 61% of our trade was with the EU. Today this is 43% and falling. Non EU trade makes up the majority of our overseas trade, is rising and is in surplus.

In stark contrast the UK economy is looking relatively vibrant. Figures yesterday revealed that UK Retail Sales grew at their strongest level in 2 years in the last quarter, and consumer sentiment remains firm. Yesterday Employment figures showed that the UK has full employment, with less than 5% unemployed. Manufacturing, Services and Industrial production are all performing well.

What does this mean for GBP/EUR exchange rates? 


The above should mean a strong Pound and a weak Euro, however as you’ve probably noticed, the opposite is true. Good for exports perhaps, not good when it’s causing inflation to rise too fast. If it rises above wage growth then real incomes will start to be affected. What this shows is that it is politics rather than fundamental data that is driving the value of the Pound at the moment, and due to this Sterling remains subdued due to uncertainty over what trade agreements the UK will be able to make with the EU, and the rest of the world, next year. Once there is a clearer picture of what the UK economy will look like, there is every chance that the Pound will rise and exchange rates recover. However the road is a long one, and while uncertainty remains, its likely Sterling will remain low against other currencies. If focus starts to shift to the fundamentals however, we could see rates recover.

We’ll end today’s report on a positive note with some light economic history. The immediate reaction to the UK leaving the Gold Standard in 1931, and again to sterling’s exit from the ERM in 1992, was similarly adverse, and even alarmist. Yet on both occasions the lower exchange rate helped to secure a following period of robust economic growth. Let’s hope history repeats itself.

For the sake of both the UK and EU economies, let’s hope that when Article 50 is triggered, the 27 member states are familiar with Article 8.