Sterling hits 31-year low; report on ECB helps euro

The sterling stumbled to its weakest against the dollar in 31 years on fears over Britain's looming exit from the European Union, while the euro ...

Tue Oct 4, 2016 | 8:12pm BST

An employee is seen walking over a mosaic of pound sterling symbols
set in the floor of the front hall of the Bank of England in London,
Britain 25, 2008. REUTERS/Luke MacGregor/File Photo

By Richard Leong | NEW YORK

The sterling stumbled to its weakest against the dollar in 31 years on fears over Britain's looming exit from the European Union, while the euro recovered much of its losses on a report that suggested the European Central Bank might scale back its bond purchases.

The dollar broadly strengthened on upbeat economic data and bets on a year-end U.S. interest rate increase.

The pound has fallen almost 2 percent since British Prime Minister Theresa May's announcement on Sunday that the formal process to take the nation out of the EU would start by the end of March.

"Everything people are hearing from the UK is not positive for its currency," said Paresh Upadhyaya, director of currency strategy at Pioneer Investments in Boston.

Many in the market worry that the British government's stance points to a "hard Brexit," in which Britain splits entirely from the single market in favor of retaining control over immigration, which could drive an exodus of banks from London.

The sterling was down 0.8 percent at $1.2738 GBP=D4 after falling earlier on Tuesday to $1.2720, its weakest since June 1985. It has declined about 15 percent since Britain's June 23 referendum on EU membership.

The pound was down 0.8 percent at 87.94 pence per euro after setting a three-year low against the single currency earlier Tuesday. EURGBP=

In addition to the pound and euro, the greenback rose against four other major currencies as measured by the dollar index. It was up 0.5 percent .DXY after hitting a 13-day high following an upbeat survey of the U.S. manufacturing sector on Monday. The encouraging report caused investors to raise their bets on a rate increase by the end of the year. ECONUS

On Tuesday, Richmond Federal Reserve President Jeffrey Lacker said there was a strong case for raising interest rates and that borrowing costs might need to rise significantly to keep inflation under control.

U.S. interest rates futures suggested traders see a 63 percent chance the Fed will raise rates at its Dec. 13-14 meeting, up a touch from late on Monday, according to CME Group's FedWatch program. FFX6

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The euro pared its earlier drop following a Bloomberg report that said the European Central Bank will probably gradually wind down bond purchases before the end of its quantitative easing program, which is intended to help the euro zone economy.

"That gave the euro a bounce, but the euro zone is still continuing to work through its issues. There is only so much you could do with QE and negative rates," said Minh Trang, senior FX trader at Silicon Valley Bank in Santa Clara, California.

The single currency was down 0.1 percent at $1.1202 after falling to a near two-week low at $1.1135 earlier Tuesday. It was up 1.2 percent at 115.14 yen, not far from a three-week peak. EUR= EURJPY=

(Additional reporting by Jemima Kelly; in London; Editing by Andrew Heavens and Lisa Von Ahn)

http://uk.reuters.com/article/us-global-forex-idUKKCN12401D

Europe’s QE Quandary

Battles Over Bond Buying

By 

Jana Randow

 | Updated Sep 8, 2016 4:22 PM UTC

It’s the new conventional wisdom: When all else fails to make economies grow, create new money and buy government bonds. That’s the formula dubbed quantitative easing, or QE. Most economists think it helped keep the U.S. and the other countries that used it — including Japan and the U.K. — from tumbling into a catastrophic depression. Will it work in Europe, too? It’s been difficult for the 19-nation euro area to do the same thing, partly because of different interpretations of European Union rules, and partly because it could undermine efforts to push governments to do more to revive their economies. But after the European Central Bank exhausted other options, it pressed ahead with full-blown QE

The Situation

Europe’s central bank began buying government bonds in March 2015 — six years after the U.S. embarked on QE — as the region’s fragile recovery lagged the rest of the world. President Mario Draghi overcame German-led opposition on the bank’s Governing Council and initially embarked an asset-purchase program worth about 1.1 trillion euros ($1.2 trillion). Yet inflation still remained far below target, so the planned length of the program was extended in December. In March, Draghi announced that monthly bond buying would be increased by a third and the ECB began purchasing corporate debt in June. The central bank finally turned to QE after cutting one of its main interest rates below zero in 2014, the first major institution of its kind to ever try such a move.  The stimulus sent the euro tumbling to its lowest level against the dollar in a decade and pushed yields on some government bonds into negative territory. The ECB is also still providing cheap funding to any bank that needs it in its regular lending operations — a sort of temporary, on-demand version of QE. It began buying covered bonds in October 2014 — a type of debt secured by a pool of loans, such as mortgages — and added asset-backed securities in November 2014.

The Background

The treaties that founded the modern EU prohibit the ECB from financing governments and broad buying of government bonds tests that idea. Germany’s Bundesbank, whose iron grip on prices after World War II helped to soothe German memories of 1920s hyperinflation, has been particularly outspoken against expanding the supply of money. The argument: The moves reduce the incentives for governments to stop overspending and make their economies more competitive. For the Germans, it’s a matter of principle, even though deflation, or a fall in prices, has been a bigger threat than inflation. Before Draghi suggested in September 2014 that the ECB could add as much as 1 trillion euros to its balance sheet, the scale of its stimulus measures had been small. Government bond purchases never exceeded 9 percent of total assets, and all the stimulus added up to less than half of the balance sheet in 2012. In the U.S., by contrast, bond purchases that ended in October 2014 quadrupled the Fed’s balance sheet to more than $4.5 trillion. Despite the controversy, asset purchases aren’t new to the ECB. It bought sovereign debt from countries such as Greece, Spain and Italy in 2010-2012, and covered bonds in 2009-2012.

The Argument

Fed-style QE in Europe has overcome both practical and political challenges. Companies get most of their funding from bank loans rather than selling bonds, which is more common in the U.S. That makes European financial markets smaller and much less liquid. Government funding costs also vary widely across the bloc. The ECB has been buying sovereign bonds proportionate to the size of its member countries, so the bulk comes from nations like Germany and France, where yields have fallen below zero. There’s also still a debate about the effectiveness of QE and concern that it fuels asset bubbles as the money flows into stocks and other assets instead of benefiting companies and households. The current QE program was preceded by a bond-buying planned dubbed Outright Monetary Transactions that followed Draghi’s pledge in 2012 to do “whatever it takes” to save the common currency from collapse. The arrangement, which calmed markets at the height of the euro zone’s debt crisis and helped the region emerge from its longest-ever recession, was never tested.

The Reference Shelf

• An article by Martin Feldstein, professor of economics at Harvard University, on the shortcomings of QE in Europe.
• ECB statement from March 2015 on its bond-buying program and a website with details of the expanded asset-purchase plan.
• A November 2015 research paper from ECB economists.
• A guide to the ECB’s QE program from the think tank Bruegel.
• Draghi’s speech from April, 2014 outlining possible policy responses and aspeech by ECB Executive Board member Benoit Coeure from September, 2013 on the OMT bond-purchase program.
• Research paper from the Federal Reserve Bank of St. Louis comparing QE policies of the world’s four major central banks.
• QuickTakes on negative interest rates and currency wars.

https://www.bloomberg.com/quicktake/europes-qe-quandary