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The AED - UAE Dirham weekly update
28 Jun 2010
In this week's update:
A GOOD BUDGET FOR STERLING
Britain's triple-A credit rating is no longer under threat. Investors are less relaxed about the cost of the US recovery strategy.

Since the 1970s the dirham has been pegged to the US dollar at a rate of Dh3.6735 to $1. The UAE declared last year that it will not participate in the future Gulf currency union and has recommitted itself to the dollar peg. As long as that rigid link exists the sterling/dirham exchange rate will continue to depend entirely on what happens to sterling/dollar.

There was a setback for sterling, on Monday and early Tuesday, that took it down through Dh5.48 to Dh5.39 ahead of the budget speech in parliament. Afterwards it was upwards almost all the way. Sterling hesitated at Dh5.51 on Thursday and end-of-week profit-taking saw another base form at Dh5.46. Investors were more enthusiastic this morning, allowing sterling to open in London at Dh5.52, its highest level for six weeks.

Mercifully, Britain's currency is doing better than its football team. There was no obstacle for sterling among the very few economic data that appeared during the week. The British Bankers' Association figures for mortgage lending showed a very slight increase in May and the Confederation of British Industry's distributive trades survey (a sort of private sector measure of retail sales) improved from -18 to -5. The minutes of the Bank of England's June Monetary Policy Committee meeting produced a positive surprise for sterling when they revealed that one MPC member, Andrew Sentance, voted to raise interest rates by 25 basis points from 0.5% to 0.75%%. Although the other eight members thought it better to leave the Bank Rate unchanged, , investors were heartened by the idea that rates can go up as well as down.

The main event for sterling was the much-trumpeted 'emergency' budget from the coalition government. For the person in the street there was no escaping the pain that the chancellor was dishing out by the bucketful. For sterling, however, the return to prudent stewardship of the economy was a godsend. For the first time investors could live with the growth forecasts that would make the formula work. Taking into account the measures set out in Mr Osborne's budget, the New Office for Budget Responsibility reckons the economy will grow at annual rates of 1.2%, 2.3%, 2.7%, 2.9% and 2.7% in the next five years. Those are not big numbers but they are credible. The market also has faith in the OBR's projection that government borrowing will fall from 10.1% of gross domestic product to 1.1% over those five years.

It will take time to see whether the government can deliver on its promise to reduce departmental spending by a fifth. However, there seems little doubt that it will do its best to make the savings. As far as investors are concerned, that is good enough for the time being. The ratings agencies are on side as well. One of the chancellor's opening remarks was to the effect that he was keen to preserve Britain's top-drawer AAA credit rating and the agencies were quick to say they had no problem with that.
There was no shortage of statistical evidence from the US economy. Unfortunately, most of it was not particularly helpful. An ongoing theme was weakness in the residential property market. With the expiry of a tax credit scheme for homebuyers, turnover has fallen off a cliff. Existing home sales fell by 2% in May and new home sales were down by a thumping 32.7% to an all time low (records began in 1963). Durable goods orders were down by 1.1% on the month. Friday's revised figures for gross domestic product in the first three months of the year were another disappointment. Annualised growth of +2.7% was appreciably less than the previous +3.0% estimate.

Although the US dollar is still the world's primary reserve currency investors are beginning to express concern at the president's compulsion to chase growth almost at any cost. If the squillions already spent have not been enough to generate trend-line growth, how much more money might Mr Obama be persuaded to print in pursuit of prosperity? Advocates of the Obama stimulus approach argue that Britain and Germany, with their efforts to bring down borrowing, amount to deficit fetishism. Critics say the States are trying to spend their way out of debt.

At its current levels sterling is encountering technical resistance. Once that is out of the way sterling could have another five cents of obstacle-free progress ahead of it. Buyers of the dirham should hedge less than 50% of their requirement and hold on for better levels.

For more information and expert guidance on the currency markets, call Moneycorp today on +44 (0)20 7589 3000. Alternatively go to www.moneycorp.com where you can open a free, no obligation Trading Facility.

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