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UK Pound Weakens in Face of Rising Budget Deficit

Added: February 25, 2010
The euro continued to weaken against most currencies as the Greece debt problem remains unsolved. Greece is facing another credit rating reduction if it becomes apparent the budget deficit cutting plan will not work. Hedge funds buying the yen lead to a stronger yen against major currencies. The UK pound weakened as the Bank of England indicates it may resume the quantitative easing program. The Brazil real and Mexican peso strengthened even as higher unemployment numbers are reported.

The Greece financial problems continue to drag down the euro. The euro fell against the yen to a twelve month low when it reached 120.44 yen yesterday. The euro also weakened against the US dollar to $1.3461.

Greece faces a possible downgrade in its credit rating. The rating is currently at BBB+ and further cuts are expected by the end of March. But yesterday’s big euro drop is credited more to hedge fund purchases of the yen rather than debt problems in the European Union.

Standard & Poor’s has given notice that it may lower Greece’s credit rating and expressed concern that the government will not be able to meet its budget reduction plan over the next three years. Greece will most likely need financial assistance to avoid default on its debt but the European Union commission that has been working on finding solutions to Greece’s financial problems has been unable to agree on any rescue packages.

Greece has experienced persistent government employee walk-offs in protest of budget cuts needed to reduce the budget deficit. The impasse is causing great concern that Greece’s government will not take the hard steps necessary to bring its finances in line with EU requirements. The situation is not hopeless though if the government should choose to maintain the austerity plan proposed and the financial picture improves. Further cuts in the credit rating will make it very difficult for Greece to borrow from the European Central Bank as bonds could no longer be used for collateral.

Though Greece has been overshadowing the currency markets, the news in other countries is not particularly good. The Federal Reserve Chair Ben Bernanke gave a state of the monetary policy report to Congress yesterday and the news was grim. He reported that interest rates will stay low for an indefinite period of time because of a weak job market.  Inflation also remains low. It has been said for many weeks that the high unemployment rate would be a drag on the economic recovery.

The US dollar weakened against the Japanese yen to 89.66 yen.

UK sterling reached a nine month low against the US dollar at $1.5332. Sterling also fell to 137.29 yen.  Sterling is feeling pressure as a result of the Bank of England indicating it may resume the policy of quantitative easing, The UK budget deficit continues to grow and that is adding vulnerability to the pound.

The UK budget deficit is now at 12 percent of GDP. What makes the UK different from Greece is that the UK can print more money to stimulate the economy and then withdraw the asset purchase program when the time is right.  Greece adopted the common currency euro and does not have the same opportunities.

There is a UK election in June and there is a lot of uncertainty as to who has the majority right now. If Prime Minister Gordon Brown is ousted there could be major monetary and economic changes in the UK coming.

The Brazil real rose to 1.8246 reais per US dollar. The unemployment rate in the nation increased in January to 7.6 percent.

The Mexican unemployment rate also reported a January increase to 5.3 percent. The Mexican peso strengthened to 12.8090 pesos per US dollar.

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Hocus Pocus Money

Avatar Posted by John Miller at Feb 25, 2010 08:34 AM
Quantitative Easing is a difficult monetary policy to manage. It is described as printing money and then using that money to buy assets like securities. But what many don’t realize is that money isn’t actually printed. Instead the central bank and the other banks swap around securities for reserves. It’s all accounting hocus-pocus involving balance sheet entries. The idea is that the non-central banks will decide to keep their balance sheets in balance by expanding lending. It doesn’t always work that way which is why the USA has been confounded by banks continuing to drag their feet about expanding credit even after completing these swaps.

The USA doesn’t call their swaps quantitative easing but it’s the same game being played in the UK. Despite billions of new reserves in pounds and dollars recorded on bank balance sheets, credit remains tight as ever and that chokes off the creation of new jobs through business expansion and consumer spending. This policy also creates a real threat of currency devaluation and inflation. It is alarming when analysts write that the UK and US can just print some more money and pay their debt as if this practice will never have any consequences. Anyone who follows the currency markets or any other financial market knows that it can take years for the catch-up consequences of poor fiscal and monetary policies to take effect.

I believe that using this sleight of hand of quantitative easing is a bad policy. Politicians are like drunken sailors careening on a dock and about to fall off as they spend stimulus money by the barrel trying to revive the economy. The bank balance sheet entries resulting from quantitative easing are mindful of the ghostly value of derivatives that caused this mess in the first place.

Derivatives

Avatar Posted by Jeanine O'Reilly at Mar 01, 2010 12:46 AM
It is very disturbing to discover that derivatives are still playing such a large role in the financial markets. Derivatives, or credit default swaps, may make some of the hedge funds and a handful of all ready wealthy people even wealthier, but what about the average investor? Just the thought of derivatives being actively used to help Greece hide its debt for years when derivatives caused the recession in the first place is sickening. Now derivatives are used to hedge bets against Greece’s debt. I didn’t really expect derivatives to disappear but I did expect that some regulations would have been put in place by now by the EU, the UK, and the USA. But there are still none so that means risky investments by hedge funds are building again except now they are underpinning governments like Greece.

A couple of months ago the Wall Street Journal had an article that addressed continued risky behavior on the part of banks investing in hedge funds. To be honest, I didn’t really believe it would continue because the government regulators were getting ready to put hedge funds under the same microscope as other financial investments. In the last year alone, the value of swaps to insure Greece’s debt has doubled! The value is now at $84.8 billion. That is incredible and makes me wonder if Donald Morgan who is with the hedge fund Brigade is right. He said that the Greek debt is going to start a ripple effect of defaults that will reach down as low as municipal debt. What does this mean for the euro? It can’t be good.

Euro Parity

Avatar Posted by Jim Kelley at Mar 01, 2010 12:46 AM
When you look at the technical charts for the euro, the last two months have been hard on the euro. It was considered to be the currency with the most potential for strength until the truth came out about Greece and also Spain and Portugal. Now there is renewed talk that the euro could reach parity with the US dollar. That’s a big fall for the euro. It has already dropped from $1.51 in December to its current $1.30 plus or minus a few cents. The opportunities for the big investors to make millions on a continued euro weakening are tremendous when using leveraged investments. If I was a big player, I would have some real worries about making such a bet on euro dollar parity. With Germany handling the committee looking at ways to help Greece, the euro could possible stop its free fall. There is some speculation that an agreement is going to be reached as to how best prevent Greece from defaulting on its debt despite Germany’s adamant statements a loan will not be approved by the EU. It is in Germany’s interest to make sure the euro is not undermined by a defaulting member nation.

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