Foreign Currency Exchange

Last week, the euro weakened against the pound, following negative data throughout the week. GDP in the Euro zone almost halved in Q4, showing growth was hit by reduced government and household spending. Jean-Claude Juncker (Luxembourg’s Finance Minister) noted that growth in the Euro zone was slowing and that the exchange rates do not reflect fundamentals adding that, “In the present circumstances that we face, we are concerned about excessive exchange rate moves.”

The ECB left rates on hold at 4% on Thursday with the ECB downgrading growth forecasts for 2008, while increasing their inflation forecasts. During the following press conference, ECB president Jean Claude Trichet placed emphasis on inflation in what was a slightly hawkish statement, although still dovish compared to a couple of months ago.

Last week’s data and the ECB’s comments have once again highlighted the dilemma the ECB faces, as inflation risk continues, but growth is slowing. Despite the slightly bullish comments, it is still expected that the ECB will look to cut rates at some point in the next quarter. If the ECB leaves cutting rates too long, then they could risk harming the European economy which could also result in the Euro weakening. Therefore, it is felt that the Euro could depreciate, as more people will look to price in expectations of an interest rate cut. Even though the outlook for the UK economy is bleak, the market has already partly priced in these concerns and therefore the cross could start to move higher over the next few months. That said, it currently looks as though momentum is to the downside, in which case we will need to see some contradictory data to create this movement.