With the threat of an imminent Greek exit from the euro zone having now lifted, foreign exchange markets have breathed a huge sigh of relief. Whether this is a permanent or temporary respite remains to be seen but for the moment at least some calm has returned.
Much credit for the improved sentiment must go to the European Central Bank. Taking a far more activist policy stance under the Presidency of Mario Draghi, official interest rates have been cut twice and enormous liquidity injections have been sent into the banking system. Both the price and the quantity of money have been changed, leading to significant falls in bond yields and credit spreads across Europe.
Economic data across the Continent still point to a challenging near-term outlook, with some Southern countries in recession as formally defined by two consecutive quarters of negative growth. Nonetheless, financial stresses have eased considerably and there are genuine grounds to believe this will help the real economy in the second half of the year.
The fact of lower tensions in wholesale money markets and the hopes for an increase in economic activity have combined to lift the external value of the euro. It is almost 6 cents off January’s low against the US dollar, at a four month high of 106 against the Japanese Yen, and is just beginning to claw back some of its earlier losses against the British Pound.
At the beginning of the year, sterling had been seen as a “safe haven” for those investors looking for European exposure without the attendant euro uncertainty. Sterling/euro climbed to its best level in more than a year.
With a very disappointing fall in Q4 GDP, a shift to “negative outlook” on its credit rating and confirmation that some members of the Bank of England’s Monetary Policy Committee would like to do even more Quantitative Easing, the pound has already lost 3 cents against the euro. Ahead of the Chancellor’s Budget on 21 March it would be no great surprise to see sterling slip a little further.
Every exchange rate is, of course, a relative price. The euro may not be completely out of the woods, but in the short-term it no longer looks the worst of a bad bunch. And that, sometimes, is all it takes to push a currency higher.