Newsletter article

Currency Report - January 2013

It isn't just Britain that has been feeling the bite of winter winds. From the Black Sea to the Mediterranean early snow has disrupted travel and made outdoor life miserable. Croatia has endured its worst winter storm since 1955.

The euro has begun to feel the pinch too. In one unlucky week in early December the single currency took two hits, distracting investors from what they perceive as a new mood of determination among EU leaders and forcing them to concentrate instead on more basic practicalities.

The first problem appeared at the European Central Bank president's monthly press conference. Mario Draghi presented a new and more gloomy set of economic forecasts. He also revealed that the Governing Council had discussed the possibility of negative interest rates (this is to say negative nominal interest rates; real interest rates in Euroland are already negative, as they are in Britain and the United States, because the inflation rate exceeds the interest rate). For investors there is nothing to like either in negative interest rates or a longer period of negative economic growth.

A couple of days later the euro encountered its next problem. The technocrat and apolitical prime minister of Italy, Mario Monti, who was appointed by the president to sort out the country's fiscal position, announced that he would retire once parliament had approved next year's budget. The fear is that his successor will be less diligent in his efforts to reduce the country's burden of debt. To add insult to injury, the disgraced Silvio Berlusconi announced that he wanted to be Mr Monti's replacement. Any derailment of Italy's austerity programme would undermine confidence in Euroland as a whole.

The euro fell against the pound and the Croatian kuna's not-quite-a-peg to the euro sent it lower too, taking the pound back up to its position at the beginning of November. Over those six weeks the kuna's value remained between 7.50 and 7.55 to €1, towards the weaker end of the 7.40 – 7.60 range that has contained it since June 2011.

With Christmas only a fortnight away investors will not be desperate to get too involved in pushing currencies around. Most will be far more keen to preserve any profits generated in the previous eleven and a half months. The end of December is, for many investors, the end of their accounting period and the point at which their efforts for the year are judged.

So look for FX activity to wane as the festive season approaches. It does not necessarily imply less movement: moves can become exaggerated in thin markets. But spikes and troughs resulting from limited liquidity are usually not an indicator of underlying direction. Beware of reading too much into them if they occur. Things ought to get back to normal in the second week of January.

With EU accession scheduled to take place in six months' time there are still rumbles about Croatia's suitability for EU membership. The European Commission has listed ten specific problems which must be solved before accession can take place. Some of them are hard to quantify, such as prosecuting war criminals and improving the justice system, so could pose a subjective obstacle to entry. Towards the end of 2012 there were also questions about the weakness of Croatia's economy and how EU membership could make recovery more difficult to come by.

Recently, however, research by Erste [banking] Group has painted a more positive picture of the Croatian economy. Erste Group's paper, released at the end of December, said; "After Croatia's EU entry in July, we see up to 2.5% of GDP growth in 2014-2020 due to access to common market and to EU funds." Another big firm is similarly optimistic. IKEA has applied for permission to open its first shop in the country, near Ivanja Reka on the east of Zagreb.

At least the folk in Brussels have no reason to worry about the Croatian currency. The kuna continues to track the euro, if not exactly with pinpoint accuracy than at least in a consistent way. For most of the last three months one euro has been worth between 7.50 kn and 7.55 kn. For the last 18 months there have been between 7.4 and 7.6 kuna to the euro.

The effect has been to make sterling's performance against the kuna look very like its performance against the euro. Compared with its position at the beginning of last year the pound has strengthened by a net three euro cents or 2.6%. Against the kuna sterling has climbed from 9.0 to 9.3, an improvement of 3.3%. The difference comes from the kuna's net -0.7% depreciation against the euro over the same period.

Sterling's success in 2012 should not be overestimated. It did well during the first half of the year but it has been on the retreat since late July. The euro begins 2013 with a much higher level of investor approval than it enjoyed a year ago. At the beginning of last January there was good reason to suspect that Greece would have to pull out of the single currency. Today there is equally good reason to expect that not to happen. Investors no longer foresee the dissolution of the euro; they see instead a mood of determination with EU leaders and central bankers doing whatever it takes to preserve it.

Sterling got lucky at the beginning of last year. It might not have the same good fortune in 2013.


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