Currency Management

Currency Report - July 2014

The Croatian football team's entourage will not have a great deal of interest in the quarter-finals of the world cup, their team having been knocked out of the tournament after just three matches. But at least Croatia managed to score half a dozen goals, actually winning one of the matches, and fared no worse overall than those other once-great footballing nations; Spain, Italy and England.

And by the look of it, Croatia's economic performance in the first quarter of the year was no worse than that of the United States. That is not to say it was a good performance; in both countries gross domestic product decreased in the first three months of 2014 and for Croatia it was the tenth successive quarter of negative growth. If Croatia's currency had a life of its own it would not be hard to imagine it falling in value in response to such a long period of economic shrinkage. But in fact since the beginning of 2012, when the first of those ten quarters of decline was reported, the value of the kuna against the euro is unchanged at around Kn7.57 to €1.

The kuna is virtually unchanged against the euro over the last month too, although both currencies have weakened by -1.5% against the pound. The euro's problems continued to centre on the excessively low inflation rate in Euroland, 0.5% at the last count, and what the European Central would - or would not - do to bring it back up to its 2% target.

In early May the ECB said it was "ready to act" with policy changes what would achieve that aim. In early June the central bank announced what the changes would be; lower rates, including a -0.1% interest rate on deposits from commercial banks, and a subsidy to encourage banks to lend to the individuals and small firms that have found it difficult to borrow since the financial crisis began.

The programme was much as investors had expected so there was no huge and immediate reaction when it was announced, but there has been a steady erosion of the euro that has taken its value down to £0.80, putting sterling/euro at €1.25. Investors continue to prefer the pond to the euro because as the ECB relaxes monetary policy with lower interest rates the Bank of England is preparing to take it own benchmark rate higher.

The timing of the first sterling rate increase is a matter of considerable speculation. After two alterations to the BoE's "forward guidance" in as many weeks investors can no longer be sure what, if anything the Old Lady wants them to believe. The suspicion is that the first sterling rate increase will come before the end of the year, and that it will be smaller than the traditional quarter-percentage-point increase, but nobody can be sure.

It is likely that the pound will continue to edge higher against the euro and the kuna. However, the Bank of England's reluctance - or inability - to offer consistent guidance on the matter means there could be increased volatility along the way. .

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