International Finance - Currency - Essay Example

1 Run -up to 2003 The pound began its journey in the year 2003 in the international FOREX market with mixed fortunes establishing a clean lead in the previous year over the world major and leading currency, the US dollar but losing phenomenal ground against the budding Euro. Pound sterling rose against the US currency from $ 1.445504 to $ 1.610695 but fell against the Euro from 1.598569 on January 1, 2002 to 1.534944 on December 31, 2002. These values are obtained for different periods after making graphs electronically (Currency graph and FOREX charts). Same method is applied for obtaining the values mentioned at other places and tables elsewhere also in this paper. Downslide continues FOREX experts thought that the pound would begin the year 2003 on an optimistic note but unfortunately for the pound, that year also began with a downward trend against the Euro and continued till the year end. The first quarter saw the pound value against euro drip by 5.8% from 1.539429 to 1.449098. It further continued the downward journey to 1.438329 by the end of second quarter reaching its lowest of the year at 1.397857 on May 30. The decline in the second quarter was 0 .7 % and negligible when compared to the first quarter decline. On the whole, the pound dripped by 6.56 % during the first half of the year which had seen the euro rise against the pound from 0.649591to 0.695251. The following table and the subsequent graph show the decline of the pound against the Euro as explained earlier in the first half of the year 2003. 2 Date / Month Value of 1 GBP Value of 1 Euro in terms of Euro in terms of GBP 2 1 1. 539429 0.649591 30 1 1 .529984 0.653601 28 2 1. 455608 0.686998 31 3 1. 449098 0.690085 30 4 1. 430236 0.699185 30 5 1. 397857 0.715381 30 6 1. 438329 0.695251 3 Consistency in EU bank rates The European Central Bank (ECB) has continued with a policy of consistency in bank rates boosting up the morale of the Euro in FOREX markets. In January and February, 2003, the Governing Council of ECB decided to continue with existing rates of 3.75% and 1.75 % for marginal lending and deposit facilities respectively. The minimum bid rate on main refinancing operations also continued to be at 3.75% putting at rest all the rumours. This was followed by a report, released on February 24, 2003, that claimed that the solvency levels of EU banks also continued to be even stronger. The regulatory capital ratio for EU banking system stood at 12% as against the minimum requirement of 8% in the preceding two years of 2001 and 2002, according to this report (Press release, 24 February 2003-EU Banking sector stability, The banking sector has remained stable). While these decisions helped the Euro maintain its stability and uptrend against the pound, some unfavourable trends persisted on the home ground for the latter currency adding fuel to the fire. No doubt, the British economy had recorded maximum growth rate in the third quarter of 2002 due to buoyancy in consumer spending and rising of prices while the GDP rose by 0.94 % in comparison with the previous quarter. But the inflation rate had crossed the Bank of England's (BOE) expected target of 2.5% reaching almost 2.8% in the last quarter (Released on 1/9/03 For 4 Jan 2003 ). The BOE defended the inflation rate arguing that the tendency was temporary and had its sources in the rising prices of oil and housing. With a view to reverse the inflation trend, the BOE had reduced the interest rate to 3.75 percent from 4%. This was the lowest level borrowing rate in the country since 1955 (Released on 2/6/03 For Feb 2003) and it naturally made the public and FOREX traders lose interest on the pound leading to its continuous downtrend against the Euro. The following table shows how it went down further in the second half of the year 2003. Date / Month Value of 1 GBP Value of 1 Euro in terms of Euro in terms of GBP 1 7 1. 438028 0.695397 31 7 1. 433634 0.697528 31 8 1. 436573 0.696101 30 9 1.425592 0.701463 30 10 1.463252 0.685880 28 11 1.435523 0.696610 31 12 1.416401 0.706015 5 The above table shows the fall of the pound against euro from 1. 438028 on July 1, 2003 to 1.416401 at the end of December equalling to a fall of 1.5 % in the 6 months. This clearly shows that though the pound continued to fall against the euro, the downtrend rate has reduced considerably in the second half of the year when compared to the first half. The main reason for this very low rate of decline is that the ECB has also reduced the marginal lending and deposit interest rates to 3.5 % and 1.5 % from 3.75% and 1.75% respectively on March 6,2003. Steps to reduce inflation BOE took another step in July 2003 reducing the interest rate further by 0.25 % to bring it to the level of 3.5% from the February rate of 3.75% (news release).The bank announced that the reduction was necessary to keep the inflation in check. This was also one of the factors, along with a slow down in services and manufacturing sectors of the country, for the continuous downward journey of the pound against the euro in the second half of 2003. In fact, the inflation rate continued above the target level till September 2003, though it reduced from its peaks of 3% around March 15. After reviewing the economic conditions and assessing the situation, the BOE had enhanced the interest rate to 3.75 % on November 6 following reports of picking up of manufacturing sector amid sustained growth of demand for consumer products. Year 2004 The economic measures implemented by the BOE had yielded expected results during the first half of the year 2004 boosting up the value of the pound against the euro. Pound shot up by 6 4.54 % from 1.426983 euros at the beginning of January to 1.491893 euros the end of June 2004. The following table and subsequent graph show the gradual growth of the GBP against the euro. Date / Month Value of 1 GBP Value of 1 Euro in terms of Euro in terms of GBP 2 1 1. 426983 0.700779 30 1 1 .462154 0.683922 28 2 1. 494381 0.669173 31 3 1. 498773 0.667213 30 4 1. 484286 0.673725 30 5 1. 503526 0.665103 30 6 1. 491893 0.670289 7 Interest rate up again BOE had enhanced the interest rate in February 2004 by 25 basic points to 4% amid reports of a buoyant housing market (Highlights). During the same period, ECB had continued with its old rates of 3% and 1 % for lending and deposit spheres respectively, having last reduced them on June 5, 2003 by 50 basic points from 3.5 % and 1.5 % respectively (Press release, 5 June 2003- Monetary policy decisions). The ECB has been continuing with the same rate regime till date. Nevertheless, the value of euro picked up in the second half of 2004 due to several reasons. In the month of June 2004, Slovenian tolar, Lithuanian litas and Estonian kroon were included in the exchange rate mechanism of euro which helped the latter stengthen. The following table shaows the decline of pound against euro in the second half of 2004. Date / Month Value of 1 GBP Value of 1 Euro in terms of Euro in terms of GBP 1 7 1. 495698 0.668584 31 7 1. 506176 0.663933 31 8 1. 479260 0.676014 30 9 1.468203 0.681105 30 10 1.435840 0.696456 28 11 1.426006 0.701259 31 12 1.413599 0.707414 8 Year 2005 Year 2005 has seen the most number of ups and downs in the recent history of pound in relation to euro. The pound began its journey against the euro on an optimistic note. Starting with an exchange rate at 1.411450 against it on January 3, it went up to 1.455883 on March 3 registering a growth of 3.14 %. But it crashed to a low of 1.432971 on March 14 due to rumours of interest rates going down. But rumours are rumours and again the pound picked up speedily to reach a peak of 1.506774 on June 26. The month of July turned unfortunate for the pound. Terrorists bombed the London transit system on July 7 killing 54 persons and injuring several others. It sent shivers to the country's financial markets. Thereafter, the pound began its downwards journey not only against the euro but also against the USD. On July 21, it reached a low of 1.437987 going down by 4. 56 % from the heights of June 26. It was true the pound began coming down against the euro 10 days prior to the terrorist attack. Afterwards, the euro played hide and seek with the British pound in the exchange market subjecting it to severe ups and downs with the latter establishing a lead in the last week of September. Meanwhile, BOE has taken some steps with regard to interest rates. Having enhanced the interest rates for 4 times in 2004 , first in February, second time in May, third time in June and finally in August to make it 4.75 %, the BOE had reduced it to 4.5% in August 2005. 9 Surprisingly, the ECB has announced on October 13, 2005 that it was trying to strengthen its monetary relationship with the Russian economy. (Press release, 13 October, 2005 -Joint Eurosystem - Bank of Russia seminar). Russian Rouble is not a major player in the international foreign exchange market and the announcement had a bad impact on the euro. These developments have injected enough strength to pound to take on the euro. ON November 10, the euro has seen its lowest depth against the pound trading at as low as 0.647547. When compared its journey on January 1, pound on the whole maintained its strength against euro till now in the year with ups and downs off and on. This uptrend of pound in relation to euro has been attributed to the UK's services sector growth and boost up of retail sales (British pound strengthens on retail sales data). Inflation in the year stood at 1.9 % which was less than the projected rate of 2% for the year. (UK economy). But due to heavy speculation that the BOE will announce a cut in the interest rates, pound began to decline against the euro after November 10. On the last day of November 2005, Pound traded against euro at 1. 467964 (Currency Focus: BOE Speculation Pounds Sterling, first Para). ECB announcements Another reason cited for the pound decline after November 10 was the announcement made by the ECB President Jean-Claude Trichet that the bank was considering enhancing the rates after keeping them historically low for two-and-a -half-years.( British Pound Declines Against Dollar for Third Week in a Row ). 10 Conclusion On the whole, the pound is supposed to maintain its momentum against the euro next year too as the UK economy has been going ahead as per the expected estimates and the inflation continues to be below the targeted rate. References Currency graph and FOREX charts, Graph . Retrieved November 30,2005, from http://www.discount-currency-exchange.com/currency-resources/currency-graph.cfm Press release, 2003. Retrieved November 30,2005, from http://www.ecb.int/press/pr/date/2003/html/pr030224.en.html Released on 1/9/03 For Jan 2003, BOE Announcement: 2003 Release Schedule. Bank of England Policy Meeting Announcement. Retrieved November 30, 2005 from http://www.nasdaq.com/econoday/reports/US/EN/New_York/boe_ann/yyear/2003/yearly/02/index.html Released on 2/6/03 For Feb 2003, BOE Announcement: 2003 Release Schedule. Bank of England Policy Meeting Announcement. Retrieved November 30, 2005 from http://www.nasdaq.com/econoday/reports/US/EN/New_York/boe_ann/yyear/2003/yearly/02/index.html News release. Bank of England Reduces Interest Rates by 0.25% to 3.5%. Retrieved November 30,2005 from http://www.bankofengland.co.uk/publications/news/2003/077.htm 11 Highlights, 2004 Release Schedule, Released for / Feb. Retrieved November 30,2005 from http://www.nasdaq.com/econoday/reports/US/EN/New_York/boe_ann/year/2004/yearly/02/index.html Press release, 2003. Retrieved November 30,2005, from http://www.ecb.int/press/pr/date/2003/html/pr030224.en.html British pound strengthens on retail sales data, Forex reader, daily currency trading news and commentary, categories, British pound. Retrieved November 30, 2005, from http://www.forexreader.com/british_pound/index.html UK economy, June 20,2005, Retrieved November 30, 2005, from http://www.uktradeinvestcanada.org/news/index.jsp Currency Focus: BOE Speculation Pounds Sterling, Written by Daily FX Research Team. Retrieved November 30, 2005 from http://www.dailyfx.com/index.phpoption=com_content&task=view&id=5106&Itemid=62 .( British Pound Declines Against Dollar for Third Week in a Row. Retrieved November 30,2005, from http://www.bloomberg.com/apps/newspid=10000102&refer=uk&sid=aQe3NVFNG3vE Press release, 2005. Retrieved November 30,2005, from http://www.ecb.int/press/pr/date/2005/html/pr051013_1.en.html Read More