Royal Alliance Capital Currency Report

FOR IMMEDIATE RELEASE
(Free-Press-Release.com) December 2, 2011 -- Rising borrowing costs rattle markets

The euro zone debt crisis continued to dominate currency markets last week, amid rising risks it could impact more markedly on global economic growth prospects and the banking sector.

The region’s borrowing costs remained in sharp focus. The 10-year yield on Italian government bonds advanced to fresh highs above the 7% level, which is widely seen as an unsustainable level. By contrast, investors were still willing to lend to the UK and the US for 10 years at interest rates of less than 2.25%.

Sentiment towards bonds issued by heavily indebted euro zone nations soured after German Chancellor, Angela Merkel, again voiced her opposition to issuing euro-area bonds backed by all member states. Markets were also unnerved by weak demand for a German debt auction; a rise in Germany’s borrowing costs above the UK’s suggested fears the crisis could spread from the periphery to the core are rising.

The euro remained under pressure after Moody’s warned France’s AAA credit rating could be at risk owing to rising borrowing costs. A sharp rise in euro zone banks’ borrowing from the European Central Bank indicated some banks are struggling to borrow funds in wholesale markets as the debt crisis deepens. This in turn could make banks less

willing to lend to businesses and households, weakening the economic recovery. Contracting euro zone manufacturing and services sector activity, along with a plunge in industrial orders, prompted growing concerns the region might fall back into recession.

There were few domestic surprises to offer sterling direction. The Bank of England’s policy meeting minutes showed a unanimous decision to hold interest rates at 0.5% and continue with its recently announced £75 billion programme of asset purchases. The Bank also said it might need to further expand its quantitative easing measures if the situation in Europe deteriorates. A second estimate of the UK’s third quarter Gross Domestic Product (GDP) growth was unchanged at 0.5%.

The US dollar was a major beneficiary of renewed stock market declines and investor pessimism, with the pound falling below US$1.55 for the first time since early October. The US Federal Reserve’s policy meeting minutes revealed the US central bank is generally comfortable with its current policy settings, although a few members thought further monetary easing might be necessary. They also noted that the US economy had strengthened in the third quarter, although the second estimate of US third quarter GDP was lower than the earlier estimate.

Commodity-led currencies such as the Canadian, Australian and New Zealand dollars generally struggled against sterling. These currencies tend to be more sensitive to the global economic outlook. As well as the risks coming from the euro zone crisis, wider sentiment was weakened by rapidly shrinking manufacturing activity in China in November. A stronger-than-expected rise in Canadian retail sales helped to paint a brighter Canadian economic picture, boding well for domestic consumer spending growth.

Boosted by the perception of it being a safe-haven, the Japanese yen generally found favour against the pound despite Standard & Poor’s (a credit rating agency) cautioning that it might be close to lowering Japan’s credit rating. Japanese exports were 3.7% lower in the year to October, weighed down partly by the strong yen as well as lacklustre global demand.

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