The strength of the British pound against the euro today suggests that investors may be once again looking to the sterling for safety. Despite grim economic data and the prospect of easier monetary policy, the safety of the U.K. banking system is not in question and is therefore attractive to some investors. However we caution traders from being overly bullish GBP because there’s a number of potentially negative event risks this week that could drive the currency lower. Today’s consumer price report is important because inflation trends shape the central bank’s monetary policy decisions but after falling 0.5% in January, the 0.7% rebound that is expected is not abnormal. On an annualized basis, CPI is only expected to increase slightly with core CPI expected to fall. The BoE may be an inflation-fighting central but weak demand has made growth their number one concern. As a result, today’s producer and consumer prices reports won’t be as significant to sterling as Wednesday’s BoE minutes, employment numbers and 2013 Budget. The outcome of Wednesday’s reports will help investors decide whether sterling is really worth holding for safe haven purposes.
The currencies that have benefitted the most from the news are the safe havens – the U.S. dollar, Japanese Yen, British pound and Swiss Franc. The franc would have probably benefitted more if not for the Swiss National Bank’s comment that they have not excluded negative interest rates. The SNB has been quick to respond to the EUR weakness with the hopes of avoiding a flight to safety into the Franc and based on the relative strength of the GBP versus the CHF, it is working. In fact, the perceived safety of deposits in the U.K. has allowed investors to completely overlook all of the country’s problems along with the risk of dovish BoE minutes and a negative U.K. budget report this week. Unless Cyprus completely scraps the deal because of internal and external criticism, we can’t see how a good subset of depositors won’t be spooked enough to shift their funds out of the Eurozone and into other parts of Europe.
The Cyprus bailout has set the tone for trading this week and in this context, good news from any part of the world may be lost in the shuffle. Optimists argue that this situation is unique to Cyprus but we don’t know how reassuring that is as this would set a precedent for the entire region. We won’t even go into how unfair it is that senior bondholders are being saved at the expense of moms and pops and that depositors with money under their mattresses are safer than depositors in the bank. What we do know is that the Cyprus bailout has set the tone for trading in an extremely data and event risk heavy week by reawakening the fear of contagion. At bare minimum, there could be a capital flight out of European banks and slower LTRO repayments on the fear of liquidity problems. Unless Cyprus completely scraps the deal, we can’t see how some depositors won’t reconsider their investments in Europe.
Better than expected U.S. economic data may have boosted the Federal Reserve’s optimism ahead of this week’s FOMC meeting but with Cyprus reawakening systemic risks, Bernanke could choose to be more cautious. A new Bank of Japan governor will also be installed this week and they have a press conference scheduled for Thursday, March 21st. At this press conference BK Asset Management expect new BoJ officials to reaffirm their commitment to aggressive easing, which should help revive the rally in USD/JPY.
The contents of this report are for information purposes only. It is not intended as a recommendation to trade or a solicitation for funds. The author(s) cannot be held responsible for any loss or damages arising from any action taken following consideration of this information.