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Did January set the scene for the rest of the year?

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I must admit at being surprised, albeit only slightly, by how exchange rates moved in January.

Sterling had a good start to the year gaining against most other currencies. In fact, along with the euro, it was one of the world’s strongest performing currencies [a long time since we were able to say this]. And this was against a back drop of on-going austerity cuts and a 2.5 percent increase in VAT by the coalition government at the start of January. Then we had the economic growth figures for the final quarter of 2010. This clearly disappointed showing a contraction in the UK economy rather than the forecast growth. Bad weather was to blame. To be honest, this makes a lot of sense when you remember that construction – which was a key driver of growth in the third quarter – effectively stopped in December. And how many employees were unable to get to work in many parts of the UK?

Now to the euro zone. At the end of last year, the great debate was whether or not Portugal and Spain would have to go cap in hand to the European Central Bank and the International Monetary Fund given the high level of funding they required in 2011. The great fear was that international investors would shun any government debt issuance. In fact, the opposite seems to have happened as international investors, including “government” funds have made it clear – and just not through their words but by their actions – that they fully support the euro. This meant that following a brief wobble in the first week of the year when a short term debt issuance by Portugal attracted a higher interest rate than expected, the subsequent fund raisings have been well received.

The US still needs to create jobs to reduce unemployment from current levels of 10 million. As noted previously, the quantum of stimulus being applied is truly extraordinary – but it seems to be working, as recent economic data has been positive with jobs being created and the economy growing. One major problem continues to be housing and the level of repossessions [1 million in 2010]. 2013 is the predicted date when US housing will finally return to an even keel.  Until then, it will be a drag on the US economy.

The Far East continues to lead on the economic growth front but growing pains have come to the fore. The Chinese economy continues to grow at 10 percent per annum but this brings with it inflationary pressure. To combat this, interest rates are being increased with the aim of dampening growth. This has led to fallout for the commodity backed currencies that lost value in January given their dependency on continuing growth in China.

The recovery position
Australia has also suffered from extreme flooding which has resulted in the closure of a number of mines in Queensland and therefore the loss of export revenue. There is even talk of a one-off tax to cover the costs of reconstruction.

So some ups and some downs for the month of January. But do I think it is a good indicator for the coming year?

Not really. The economic recovery in the UK was never likely to be smooth. There will be some good months and some bad months. I think the fundamental readjustment that is taking place of moving employment from the public sector to the private sector is vital for longer term success in the UK. Also, the reduction in the government budget deficits will build confidence in the UK and be supportive for sterling.

In the euro zone, I wonder if we have seen a false dawn. The problems are still there -not least because the amount that is required to fund both governments and the banks is huge and not just for this year. I am sure that the powers that be will muddle through and the European Central Bank has shown itself to be reasonably adept at managing affairs – but it will be a very bumpy ride for the euro and I am sure there will be some bad months in the coming year.

The US$ has a life of its own, being the world’s reserve currency. I am sure that if the UK went for the same type of stimulus packages that we are seeing in the US, then we would see sterling plunge. There is also a great deal of politics at play with new elections forever on the horizon. And so we will see the US$ move in and out of favour as economic performance at home and events elsewhere in the world affect it.

And I see the weakness of the commodity backed currencies as a short term blip, given the remorseless way in which China is, and will continue to move forward.

So the one thing I take from the first month is that uncertainty is still with us – and I am sure will be with us for the remainder of the year.

Charles Purdy is a Director at Smart Currency Exchange, www.SmartCurrencyExchange.com,  +44 207 898 0541.

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