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Cable vulnerable to further shocks

Ajay Jaiswal

DESPERATE to achieve an economic turnaround and achieve a self-imposed target of 0.6 per cent growth in the last fiscal year, officials of Japan's Economic Planning Agency last week admitted that they had omitted weak business investment data fr om their calculations. The inclusion of this component would have resulted in a downward revision of the Q4 GDP to -1.6 per cent from -1.4 per cent.

The news has affected market sentiment and it (market) would view the stream of data coming out from Japan with caution. The ruling LDP has been trying to base its election campaign on economic recovery. The sharp fall in the stock markets does not help their cause. The Q1 2000 GDP would have to grow by around 2.4 per cent for the fiscal year GDP target to be achieved.

The euro rallied by over two per cent last Friday and touched a high of 0.9342. The ECB's strategy to speak in one voice, raising the threat of intervention and using commercial orders, has shown good results. A convincing daily close above 0.9200 indica tes that a medium-term low may be in place. The weakness in the US asset markets and possibilities of a slowdown in the US economy may lead to capital movement to the Eurozone.

Price action in the last two weeks shows that the euro has bounced back from lows below 0.90. The sharp rally took place in the absence of any news or data release. It seems that some strategic players may be turning their short positions around. The amo unt of Eurozone net investment in the US asset markets hit a record USD 231 billions last year.

The slowdown in the US economy may result in the adjustment of portfolio investments. The US durable goods orders in April showed a drop of 6.4 per cent and personal income and spending data were in line with expectations. The data in the next few weeks have to be seen for clear signals of a slowdown.

Over the last seven weeks, the ECB has seen a reduction in foreign exchange reserves of over euro 4 billions. The ECB has said that the fall is related to portfolio management of the national central bank's foreign exchange reserves. This confirms the st rategic use of commercial orders by the ECB. The Eurozone countries are trying to use the central bank reserves to meet the Government requirements.

The ECB has also stepped up its verbal intervention. The Bundesbank President, Mr. Ernst Welteke, raised the spectre of intervention to lift the euro. The ECB chief economist, Mr. Otmar Issing, called the currency's weakness a black spot on the ECB's rec ord.

The end of the week saw the dollar weakening against all currencies except against the JPY. The fall against the CHF was sharp and it lost around 2.3 per cent on Friday. This move confirms a medium-term dollar high against CHF at 1.7536.

The weakening of the sterling against the dollar in the past few weeks has abated due to the dollar weakness. However, an analysis of the UK's external balance sheet indicates that it is prone to adverse shocks. The UK has moved from being a net creditor in the mid-1980s to one of the world's large debtors.

There has been a spate of takeovers of overseas companies by UK companies. The top 10 overseas acquisitions last year were worth USD 300 billions. The data indicates that in most cases, payments have been made in shares of the acquiring companies. This r esults in the swapping of outward direct investment for inward portfolio investment. The overseas institutions currently hold 30 per cent of the UK equity market. The acquiring companies are hardly likely to sell the shares of the companies taken over. H owever, the overseas investors can sell the shares received in exchange. There is a clear sign of a reduction in direct investments and an increase in portfolio investments. This results in relatively liquid liabilities and illiquid assets on the UK's ba lance sheet, which raises the risk of a sudden lurch down in exchange risk.

The upside of the sterling may be limited and any inflationary threat may result in a sharp downward correction.

The minutes of the Bank of Japan policy meeting on April 10 indicates that they are still looking for an opportunity to end the zero interest policy. Unless there are two successive good GDP numbers, this may not be possible. Statistical adjustments in d ata will certainly not help achieve the objective.

(The author is Senior Manager, Corporate Treasury Sales -- Southern India for HSBC. The views expressed here are his own and not necessarily those of his employer.)