British Pound Vulnerable as UK Fiscal Shortfall Hits 16-Year High

Key Overnight Developments

• Bank of Japan Keeps Monetary Policy Unchanged as Expected
• UK Consumer Confidence Falls on Fiscal Deficit Reduction Plans

Critical Levels



The Euro corrected higher in overnight trading, adding 0.3% against the US Dollar. The British Pound followed suit, gaining 0.2% on the greenback. We remain short EURUSD at 1.4881 and short GBPUSD at 1.6648.

Asia Session Highlights



The Bank of Japan interest rates at 0.10% as expected and left the amount of planned government bond purchases unchanged at 1.8 trillion yen. Policymakers struck a decidedly dour tone, saying the current momentum of self-sustaining recovery is insufficient and warning that overcoming deflation is a critical challenge, with the bank unwilling to tolerate CPI at or below 0%. The bank added that although the economy is picking up, the pace of improvement will be moderate until the middle of the 2010 fiscal year.

UK Consumer Confidence deteriorated for the second month in December according to a survey from GfK, a market researcher. Most worryingly, the details of the report revealed that a gauge of consumers’ expectations of overall economic conditions 12 months from now dropped into negative territory for the first time since August. The outcome reinforced yesterday’s disappointing retail sales report. Sentiment has likely turned lower amid uncertainty over jobs as well as future tax increases and government spending cuts expected to be implemented to deal with the burgeoning fiscal deficit.


Euro Session: What to Expect



Germany’s IFO Survey of business confidence headlines a busy calendar in European hours, with expectations calling for the metric to rise for the twelfth consecutive month. Yesterday’s preliminary manufacturing and services PMI figures looked supportive, with both sectors expanding at a faster pace in December. Separately, Producer Prices add 0.2% from the previous month in November, with the annual pace of wholesale deflation moderating to -5.9% on higher oil prices.

The Euro Zone Trade Balance surplus is set to narrow to a seasonally-adjusted 5.7 billion euro in October. A stronger currency may prove the culprit for the decline. Indeed, the Euro hit a 14-month high in trade-weighted terms in October, which likely discouraged exports by making European products comparatively more expensive for foreign buyers while adding to domestic purchasing power and boosting imports. An analogous outcome is likely for the broader Current Account metric that includes cross-border investment money flows as well as trade in goods and services. Indeed, Euro Zone stock exchanges tumbled -4.5% in October, the most since February, and the ZEW gauge of investor sentiment fell for the second month having topped out in September.

In the UK, the government’s net cash shortfall (PSNCR) is set to come in at 17.3 billion pounds in November while Public Sector Net Borrowing rises to 23.0 billion, the highest on record in at least 16 years, underscoring the need for Europe’s third-largest to get its fiscal house in order. This points to spending cuts, higher taxes and rising long-term borrowing costs (as the government issues bonds to help finance the deficit), all of which promises to work against economic recovery even as the UK already lags most other G10 nations on the way out of last year’s global downturn. At worst, the outcome may prompt renewed fears of a downgrade to the UK’s sovereign credit rating, which stands to weigh heavily on the British Pound.


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