The US dollar rose to a 2012 high against the basket of the most actively traded 16 currencies in the market yesterday as Germany rebuffed calls from new French President Francois Hollande for the issuance of so called Eurobonds to help resolve the long running euro zone sovereign debt crisis.
The fact that both the IMF and OECD backed Hollande’s call seemed to have minimal impact in Berlin as Angela Merkel dismissed the proposal out of hand.
The UK was not immune from the fresh move towards risk aversion as it too fell yesterday.
Fresh data out yesterday from the Office for National Statistics (ONS) showed that the UK inflation rate fell more sharply than had been anticipated to 3%, its lowest level in two years. Analysts had expected a fall to 3.1% by the Consumer Prices Index measure of inflation which is key to governments et targets. Expectation immediately rose that the Bank of England may now have room to manoeuvre to extend its £325 billion stimulus programme, commonly known as Quantitative Easing (QE).
The data from the ONS showed that core inflation, which excludes certain volatile and seasonal prices, came down to a 29-month low of 2.1% in April, from 2.5% in March.
Vicky Redwood, UK Economist at Capital Economics, said she expected price pressures to ease further in response to contracting output and weak pay growth.
“In its recent Inflation Report, the MPC predicted that inflation would take until mid-2013 to get back to its target but we still think it will happen by the end of this year,” she said.
The ONS also reported yesterday that the UK net borrowing by the public sector dropped to a negative -£16.5 billion (a surplus) in April 2012. They were however quick to point out that this was entirely due to this month´s large one-off transfer to Government of £28 billion as part of the transfer of the Royal Mail Pension Plan. Thus, the current budget deficit excluding the temporary effects of financial interventions actually rose to £12.4 billion in April 2012 from £8 billion in March.
Net UK debt, excluding the temporary effects of financial interventions totalled £1006.3 billion or 64.8% of GDP, up from last year´s level of 60.6%. The scope for more QE and the increase in the UK debt level despite more than 3 years of austerity measures undermined confidence in the pound in trading yesterday.
The bearish move to risk aversion once again stoked demand for the safe haven qualities of the dollar, sending the dollar index to the highest level since the start of the year.
Elsewhere, credit ratings agency Fitch downgraded Japan yesterday by two notches to A+ from AA on concern about the country’s high levels of debt as it invests huge amounts of money to stimulate growth and rebuild tsunami hit areas. Fitch also warned that further downgrades could be on the cards.
Today sees a EU leaders summit and by all accounts the leaders of France, Italy and Spain, respectively the second, third and fourth largest economies in the euro zone will apply maximum pressure on Germany on moving way from a purely austerity led stance to a more balanced program of austerity and growth measures.
Ahead of the summit, analysts seem to be certain that the key message will be the following “the euro zone is united in wanting the country to remain in the monetary union, and stands ready to continue providing financial support as long as Greek commitment to fiscal consolidation and structural reforms remains in place.”
The thorniest issue on the agenda seems to be that of so-called Eurobonds, that is the issuance of national debt securities that would be issued and guaranteed by the entire euro zone, the idea being that the weakened peripheral countries would issue debt that in effect is backed by German and therefore attract German borrowing costs and not the dangerously high borrowing costs seen over the last two years which have tipped Greece, Ireland and Portugal into requiring bail-outs and have put immense pressure on Italy and Spain.