Monthly Currency Review

If there were ever any doubt about the maxim "what goes around comes around", a comparison of the best and worst performers in May and June provides persuasive evidence that it applies at least as much to currencies as it does elsewhere in life. In a league table of 11 major currencies the top four in May were the Japanese yen the US dollar and Canadian dollars and the pound. The four laggards were the South African rand, the New Zealand and Australian dollars and the Swedish krona. Lo and behold, in June those positions were almost precisely reversed.

It was a coincidence of timing of course. Investors don't divide their strategies into coherent four-week chunks. When the circumstances change, they change their minds, as famously advocated by the influential 20th century economist John Maynard Keynes. And circumstances change far more often than once a month.

One that changes repeatedly relates to banks in the euro zone. Another saying much-loved by Keynes was that "If you owe your bank a hundred pounds, you have a problem. If you owe it a million, the bank has a problem." The numbers are bigger today but the logic has not changed. Spanish banks alone need around €100bn to fill the gap caused by losses on bad loans. Following an agreement hammered out in Brussels at the end of June it looks as though they will get it from the two EU bailout funds.

News of the deal went down well with investors and the euro finished the month on a high note, rising by two cents against the dollar in a single day. Exactly how long the euphoria lasts will depend on how convincingly Brussels can flesh out the bare bones of the agreement.

While Brussels digs deep into Germany's pocket to help Spanish banks, the Bank of England is expected to spend a similar amount of cash on another round of the asset purchase programme upon which it has already spend £325bn. This quantitative easing, if it does indeed go ahead, is likely to make investors less well-disposed towards the pound for two reasons. First, the Bank is effectively (though not literally) printing the money, so diluting the value of currency already in circulation. Second, they suspect quantitative easing is subject to a law of diminishing returns that makes a third round of it less effective than the first.

Investors will take an even keener interest in what the European Central Bank decides to do at this month's Council meeting. In recent months the ECB has held back from action, arguing that it lacks the mandate and the ability to fill the gap left by indecisive political leaders. Following the Brussels agreement to support Spanish (and potentially Cypriot and Italian) banks the ECB should be more inclined to act. There will be disappointment among investors if it fails to do so.

Since Greece's problems emerged three years ago the euro has hogged the headlines, simply because the implications of its survival or failure are so huge. July's agreement is unlikely to alter that situation but, with a little luck, it could make the headlines more friendly.

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