More on Sterling, the Euro and Korea/Taiwan

The UK budget has been widely embraced. The OECD called it “courageous”. Fitch said it strengthens the UK’s triple-A status. The IMF said it was the most rapid reduction next to Greece.

The budget credibility, the lower gilt issuance and reduced risk of a downgrade is helped sterling recover yesterday from below $1.47 to almost $1.4860. Sterling’s advance continues today, where it is the strongest of the major currencies. The minutes from the MPC meeting earlier this month were more hawkish than the market expected. The noted hawk Sentence voted in favor of an immediate 25 bp hike. It is the first split decision since Feb 2009 and it is the first vote for a hike since before Lehman’s demise. The range of views seems to have widened as inflation has remained more resilient (CPI at a 17 month high in April).

The VAT hike announced yesterday may also pose an inflationary risk. However, policy makers may see through it, unless companies use it as an excuse to raise margins as well. In addition, the new “fact” since the BOE meeting is of course yesterday’s budget, which should also help ease some concerns of the MPC. In the mean time, a move above $1.4940 may run into some resistance near the psychologically important $1.50 level, but chart-based resistance is closer to $1.5050-80. At the same time, the euro appears poised to test GBP0.8200 area seen in late May-early June, which is the lowest rate since late 2008. A break could see the euro trend toward GBP0.8000.

The euro zone flash PMI was slightly softer than last month and, while this may disappoint some that had hoped the upside surprise in IFO would carry over the data is not very worrisome. The composite reading stands at 56.0, down from 56.4, but better than the consensus 55.8. Besides, that seems to be the way the PMIs work. After a recovery they begin to flag as the economic momentum, as it were, moderates.

There is concern, at least in some quarters that the “rush to austerity” will weigh on growth. The main focus remains on the European debt crisis and a growing appreciation that it is not simply a sovereign issue, like it is in Greece. As noted, more than half of German bank exposure to Spain is to Spanish banks, not government bonds. Nearly 40% of French bank exposure is to Spain’s non-banking private sector. Meanwhile, and despite the pressure on Spanish bonds today, Fitch made supportive comments about Spain’s fiscal credibility. The euro itself appears to be carving out a base around $1.2250. Resistance in the $1.2300-50 band needs to be cover come to begin repairing some of the near-term technical damage.

The South Korean won has had the strongest positive reaction to China’s yuan news. It has gained almost 1.3% against the dollar thus far this week. The won recouped some initial weakness today following reports that starting 1 July Korean officials will ban banks from extending foreign currency loans to local companies for domestic purposes. It would seem that Korean companies will still be able to hedge export revenue and import costs, but not take on new foreign debt to fund domestic operations. This would appear to further extend recent rules while limited companies from hedging more than 100% of their export revenue.

While these measures may reduce one source of demand for the won, foreign demand for Korean equities, nearly $5.6 bln thus far this year, is likely large than these corporate-related borrowings. In Taiwan as well as Korea, foreign investors were small net sellers of equities. Foreign investors have poured money into Taiwan this week. Even including the small sales today, foreigners have purchased more than $700 mln of Taiwanese shares this week, which is almost ¾ of their year-to-date purchases. There is one main driver: China—not simply the speculation on the currency impact, but also expectations that the two will sign a new trade agreement (Economic Cooperation Framework Agreement) at the end of the month. There is talk of possible Taiwanese intervention to slow the currency’s appreciation.