The Euro Continues To Strengthen

Europe – Further strengthening of the euro
The euro enjoyed strong gains again this week, strengthening to around $1.38 against the dollar and to over 85p against the sterling. On a trade-weighted basis the currency rose by over 0.5%, bringing its gains over the past month to almost 2%. This is not a particularly welcomed development given the fragile state of the euro economy recovery, as evidenced by the drop in the Composite PMI this month (to 51.5 from 52.2), and inflation at 1.1% is running well below the ECB’s target of ‘below but close to 2%’. ECB member, Coene, commented this week that if inflation falls further, or even stays static for a period, then in his view there would be sufficient reason to consider strengthening the current accommodative stance of policy. One potential way of doing so would be for the ECB to cut interest rates from their current 0.5%. It is hard to know if Coene’s view is the consensus view of the Governing Council. One of his ECB colleagues, Asmussen, said he doesn’t have any specific worry on the exchange rate; rather it only concerns him as it factors into the ECB’s inflation forecasts. All things being equal, the more the exchange rate strengthens the more it will dampen inflation.

UK – Third quarter GDP confirmed at 0.8%
UK GDP grew by 0.8% in Q3, bettering the 0.7% expansion in Q2. The data points to a robust continued recovery. Industrial output slowed to 0.5% from 0.8% in Q2 due to a fall in utilities output but manufacturing output still managed to match the 0.9% pace of Q2. Service sector output grew by 0.7% beating Q2’s 0.6% gain and the construction sector rose by 2.5% following a rise of 1.9% in Q2. Thus all sectors of the economy contributed positively to output in the third quarter. The pace of the growth confirmed the Bank of England’s expectations that growth in the second half of the year would be around 0.7% per quarter or a little higher.

The minutes of the October MPC meeting confirmed once again that members voted unanimously to keep policy unchanged. The MPC concluded that data continued to suggest a strong recovery in activity and as market rates had fallen back over the past month all members therefore agreed that there was little case for increasing the degree of monthly monetary stimulus. No member felt that policy should be tightened at present but the minutes acknowledged that the improvement in the labour markets was eroding the slack in the economy a little faster than envisaged in the August inflation report. That said, it is unlikely that the MPC will begin to talk about tightening policy anytime soon as individual MPC members have alluded to the considerable amount of spare capacity in the UK economy which will warrant loose monetary policy for some time yet. After Q3, the UK’s current level of GDP is now 2.6% below the 2008 peak.

United States – September’s payrolls weaker than expected
The shutdown delayed September payroll report was the focus for markets this week. It showed that employment rose by only 148k last month, significantly below the 180k gain expected, while the increase in private sector employment also fell short of expectations, at 128k against a forecast 180k. However the unemployment rate did fall again, to 7.2% from 7.3%, thus continuing its downward trend. With the pace of employment growth slowing considerably in the third quarter, to an average monthly gain of 143k from 182k in Q2, the Fed will want to see if this continues into the final quarter while also assessing the impact of the recent shutdown. Therefore any tapering of asset purchases is now seen as being pushed out into 2014.

This news prompted a further fall in the dollar this week, to around $1.38 against the euro from under $1.37 last Friday, and a further decline in bond yields – the benchmark 10 year yield ended almost 10bps lower at 2.5%. The upcoming Fed October meeting is not expected to yield much and policy is almost certain to remain unchanged, though they may make reference to the slower pace of employment growth recently as well as citing uncertainty caused by the shutdown. A number of other shutdown-delayed releases are due to appear next week, including retail sales and CPI for September, while the October ISM manufacturing index is also due