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Discussion in 'Money & Finance' started by John From Moneycorp, Oct 20, 2010.

  1. John From Moneycorp

    John From Moneycorp Foreign Exchange Expert


    Chancellor's spending review will coincide with MPC minutes and public sector borrowing

    AUD touches parity with the US dollar

    Sterling lost half a cent over the week but not before finding itself, at one point, two full cents lower. The rebound was not rapid as the decline, but it took the pound back almost to the top of its five-cent range.

    The two main UK economic indicators were those for the consumer price index (CPI) and employment. Neither was controversial. Inflation remained stubbornly above its 1%-3% band at 3.1% in September. Although there were 5,300 more claimants of jobseeker's allowance in September the unemployment rate dipped in August from 7.8% to 7.7% (the data are for different months).

    Unfortunately, both figures were compromised by developments elsewhere. Coinciding with the high and potentially helpful inflation figure was a speech by Monetary Policy Committee member David Miles. He said that the traditional raising and lowering of interest rates was not necessarily "the most natural tool" of monetary policy. Quantitative easing (QE), on the other hand, "remains a potentially powerful tool and one that we might come to use [again]". The spoiler for an otherwise vaguely helpful employment number was a report from accountants Pricewaterhouse Coopers. It suggested that spending cuts would mean the loss of another million jobs, half of them in the private sector as the government reined in its expenditure.

    There were not many Australian economic data. Even those that did appear had little impact on the dollar. NAB's business survey put conditions two points better in September at 7 while confidence was a point down at 10. Westpac's consumer confidence measure jumped from -5.0% to +3.3%. Motor vehicle sales were up by 0.9% in September and by 8.6% on the year. Consumer expectations (a survey of where people think prices will have gone in a year's time) jumped from 3.1% to 3.8%.

    The big news, apparently unconnected with the statistics, was the AUD touching parity with the US dollar; one-for-one. It was the highest level since the currency peg and exchange controls ended in 1983. As was the case for the Canadian dollar at roughly the same time, investors did not have the courage or commitment to pull the trigger and both of them retreated into their comfort zone. Treasurer Wayne Swan is seemingly unperturbed by the strength of his currency and has rejected any suggestion of intervention to hold it down. In his weekly economic note the treasurer commented: "Some of us remember well the last time Australia attempted to fix its currency at the same time we were experiencing a terms of trade boom in the mid-1970s. The result was headline inflation rose from around 5 percent to 17.6 percent in a little over two years." There is little dispute to the argument that the Australian dollar is making life difficult for export-oriented businesses but Mr Swan says parity is a "milestone" that reflects the "stark difference in the strength of our economy relative to other nations."

    The test for sterling this week will come on Wednesday, when the October MPC minutes and the September public sector borrowing figures provide the prelude for the chancellor's spending review. All three have the potential to derail the currency. Anything in the minutes that confirms the market's expectation of renewed QE, or any sign that government borrowing is not being brought under control, would be bad. As for the spending review, investors will use it as another opportunity to second-guess the likelihood of cuts leading to double-dip recession.

    With the prospect of collateral damage to sterling on Wednesday, investors should consider increasing their cover. Buyers of the Australian dollar should hedge at least half their requirement with a forward purchase; more than that if their capital investment is imminent.

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