Amid fears of a rekindling of Greece’s debt crisis, the pound climbed above €1.40 against the euro for the first time since the onset of the global financial crisis in 2007. Against the dollar, the single currency was at its lowest level for 12 years.
The euro’s renewed weakness came on a day of financial turbulence in which concerns about Greece, growth in China and the possibility of higher US interest rates affected sentiment across financial markets.
London’s FTSE-100 index fell by 174 points to close at 6,703, while in New York the Dow Jones industrial average fell 332.78 points to 17,662.94 erasing all the gains made so far this year. The cost of crude oil and industrial metals slid on signs that China’s economy is slowing.
But the main action was in the currency markets, where the strength of the US dollar added to pressure on a number of emerging market economies, including Mexico, where the peso fell to its lowest level on record, the Turkish lira was trading close to record lows, and the Brazilian real extended its recent decline.
The euro has been on the slide since the European Central Bank announced late last year that it was launching its own quantitative easing programme. Central banks including the US Federal Reserve, the Bank of England and the Bank of Japan have used QE to create new electronic money, but one side-effect has been to drive down currencies.
Since the start of 2015, the euro has fallen by more than 11% against the dollar and after a 1% fall on Tuesday was trading at just over $1.07. Currency traders are now braced for the single currency to fall below parity against the greenback over the coming months as further QE from the central bank is expected to be accompanied by the first interest rate rise in the US since the global recession.
A falling currency will make exports from the eurozone cheaper but also means that visitors to Spain, Italy, France and the other members of the single currency will receive more euros in exchange for their pounds and dollars.
The rising value of sterling and the dollar will also cut the cost of imports into the UK and the US, adding to deflationary pressure.
Inflation has already fallen sharply as a result of falling oil prices, with Brent crude dropping on Tuesday by 2% to about $57 a barrel.
But Mark Carney, governor of the Bank of England, ruled out the possibility that Threadneedle Street would respond to much lower than expected inflation with further cuts in interest rates or an expansion of the Bank’s £375bn QE programme.
Carney told a House of Lords committee on Tuesday that it would be “extremely foolish” to use more monetary stimulus to fight a temporary plunge in inflation caused by declining oil prices.
UK inflation as measured by the consumer price index has already fallen to 0.3% – its lowest level on record – but the governor said further falls to zero were likely in the coming months, with little subsequent change for the rest of the year.
“The thing that would be extremely foolish would be to try to lean against this oil price fall today,” Carney said. “The impact of that extra stimulus … would happen well after the oil price fall had moved through the economy and we would just add unnecessary volatility.”
Ian McCafferty, one of the externally appointed members of the Bank’s monetary policy committee – the nine-strong body that sets interest rates – said the Bank should “look through” a temporary fall in inflation caused by cheaper oil.
Speaking in Durham, McCafferty said he believed there was less slack in the UK labour market than the MPC’s collective judgment would suggest. While the threat of deflation needed to be taken seriously, he added that there was no current evidence of a deflationary psychology setting in.
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