Newsletter article

Currency Report - February 2014

Boris Vujcic, the governor of the Croatian National Bank, insisted earlier this month that his country does not need a financial bailout. He hedged his bets slightly though, conceding that "asking for an EU/IMF help programme is always an option but is not on the cards now. "Not everyone is convinced. Standard and Poor's recently lowered its credit rating for Croatia to BB, citing "continuing recession [now entering its seventh year] and limited fiscal consolidation efforts". The BB rating is two levels below investment grade and puts Croatia on a par with Costa Rica, Hungary and Portugal.

Nevertheless, the Croatian kuna is holding up reasonably well. Although it is not pegged rigidly to the euro, as is the case in Bulgaria, Lithuania and Denmark, the central bank smoothes out any spikes and troughs to keep the currency's value steady in euro terms. In the last four months the kuna has remained in a channel between 7.60 and 7.65 to €1, a variation of just ±0.3%. That is just about as steady as a floating currency can be.

Over the same period the variation of sterling against the euro was ±2.5% and, coincidentally, it strengthened by that much against the euro and the kuna over the four months. More recently, in the month since Christmas Eve sterling has risen by two euro cents. That translates into a rise from 9.14 kn to 9.29 kn.

As often discussed here, the value of the kuna against the pound is determined almost entirely by the sterling/euro exchange rate. And sterling is on a roll. After a shocking first quarter of 2013 the pound found its feet and has been moving ahead on a broad front since last summer. Over the last six months the pound was easily the top performer among the major currencies, strengthening by an average of nearly 11%. It was also at the top of the league over the last month, rising by an average of 2.6%.

The difference in performance between the euro and the pound arises from the difference between the economic conditions of the euro zone and the United Kingdom. Figures for the fourth quarter of 2013 are not yet available but the International Monetary Fund estimates that the Euroland economy shrank by -0.4% last year while Britain's expanded by 1.7%. For 2014 the IMF forecasts growth of 2.4% for the UK and 1.0% for the euro zone.

As Britain's economy gathers speed investors are looking ahead to the time when the Bank of England will begin to retighten monetary policy by taking interest rates higher. Back in August the governor said rates would not begin to rise until unemployment had fallen below 7%. At the time unemployment was 7.8% and it was though that it would take 12 - 18 month to fall to 7%. In fact unemployment is already down to 7.1% and the governor has been forced to point out that 7% is not a trigger for higher rates, it is simply one of the things the Monetary Policy Committee takes into consideration.

It is highly improbable that the Bank Rate - at 0.5% since March 2009 - will be increased this year. The governor intends to keep it low for as long as possible in order to help the economy. But it is almost certain that sterling interest rates will begin to head north well before the European Central Bank follows suit. As long as investors cling to that belief the pound is likely to outperform the euro and the kuna.

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