The Eurozone economy contracted –0.2% in Q2, yet the pound didn’t gain. So why not, and how will this affect you?
Europe’s Deteriorating Economic Outlook
You may have heard yesterday that the Eurozone’s economy shrank in the second quarter. It fell –0.2% as a whole in the months between March and June, with Portugal (-1.2%), Finland (-1.0%) and Italy (-0.8%) suffering particularly badly.
Of course, this is a consequence of the on-going debt crisis, and its effects on business and consumer confidence. Who wants to hire, when we don’t know whether there’ll be a financial meltdown in three months? Who wants to buy a new car? This is the only way to explain how otherwise robust economies like Finland would contract.
Furthermore, though the continent is not yet in official recession, because it’s only endured one quarter of contraction, it looks on the cards. Janet Henry of HSBC for instance notes, “It is clear that Eurozone GDP will register a larger contraction in Q3.” That’s not an ambiguous comment: it’s clear to Ms. Henry this is going to happen.
In addition, Aline Schuiling, an economist at ABN AMRO, comments: “What we see is a vicious circle of budget cuts, high interest rates in the periphery and sovereign debt rising.” So in other words, the situation in Europe is going to get worse before it gets better.
Yet The Pound to Euro Exchange Rate Is Unchanged
Given all this then, you might ask: Why has the UK pound not gained against the euro the last few days? Sure, sterling has wrenched some ten cents from the euro in the last six months, reaching a peak of 1.29 about a month ago. But since then it’s plateaued, and even lost ground a little. So what gives?
One reason the pound has not gained is that the countries at Europe’s core continue to avoid contraction. For instance, Germany expanded +0.3% in Q2, ahead of forecasts for a +0.2% climb. This was due to rising exports to emerging markets outside the Eurozone. In addition, France stood stagnant in Q2 at 0.0%, its third quarter on the trot with neither growth nor contraction. This though is brighter than the –0.1% contraction feared.
So for all the Eurozone’s woes, its core continues to fringe contraction. Compare that to the UK in Q2, which is after all a comparable economic power to France and Germany. The United Kingdom shrank –0.7% between March and June, one of the deepest declines in the European Union. And, bear in mind, that’s with advantages like a dedicated currency and central bank that the Eurozone lacks. Given that, would you put assets in the pound at this moment?
Is The Pound Overvalued Now?
Furthermore, there’s increasing debate on the foreign exchange market about whether the pound is now overvalued. Sterling gained in the last six months as investors fled the Eurozone, attracted to the UK’s relative political stability, and (comparatively) bright growth outlook. Yet is that now the case?
Rachel Reeves, the shadow chief secretary to the Treasury, comments “France and Germany have so far managed to avoid recession, while Britain has now been in recession for the last nine months.” That’s not a good reason to favour the pound over the euro.
In addition Matthew Cobon, currency manager at Threadneedle notes, “We get the impression that the safe haven bid is running a little thin here,” while Howard Archer at IHS Global Insight says, “Sterling is arguably overvalued.”
That then is another reason the pound has not gained in the aftermath of these Eurozone growth figures. Momentum, it seems is no longer on the pound’s side. For people planning to buy euros then, this could be a good time to lock in the foreign exchange rate, to protect them against upcoming declines in the pound.
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