Euro Currency update from Moneycorp

During most of the first half of 2010 the cut and thrust of sterling against the euro had a political origin of one sort or another. It was also sterling that did most of the cutting and thrusting: from a low of €1.0950 in early March, and after a period of hesitation in May, the pound eventually managed to make it as far as €1.2350, its best level in more than 18 months. Sterling's unique selling proposition during that period was the change of government. Optimism about the election and the result itself allowed them to become less anti-sterling. Last month's 'emergency' budget meant they could be actively positive for the first time in years. Even though they did not exactly fill their boots with pounds, buying them was no longer reason for embarrassment.

At the same time, Europe had been embarrassing itself by the horse-trading that surrounded the financial safety net for Greece. More than once it had looked as though the spat between German taxpayers and Greek tax-avoiders could end up with a default by the Greek government on its debt. Although such an outcome would have been nasty - maybe even terminal - for the euro it seemed sometimes that the burghers of Berlin would rather win a Pyrrhic victory than empty their pockets for a profligate Club Med. Investors looked on with bemusement but did not feel tempted to stock up with euros as long as Euroland states were on the hunt for a foot to shoot.

Since early July things have moved on. Greece has not declared bankruptcy, nor even made any noises about rescheduling its debts. The EU safety net has done its job and looks likely to carry on doing so. Britain's emergency finance bill has apparently put the nation on the road to a balanced budget in five years' time and its AAA credit rating is secure. Investors have been able to put political worries behind them, at least for the time being. Their worries now are economic ones.

Britain's National Institute for Economic and Social Research (NIESR) has confirmed what many investors had suspected; George Osborne's brutal budget has increased the risk of a double-dip recession. It is still not a huge risk: the pre-budget probability was one in seven; in the post-budget world it is one in five, but the risk is greater. The NIESR also mirrored the opinion of America's Federal Reserve with its prediction that it could take five years for living standards to return to their levels prior to the financial crisis. The economic data do not yet support such a pessimistic view. Britain's economy grew by 1.1% in the second quarter of the year; twice as much as expected and nearly four times the growth in the first quarter. The Confederation of British Industry reported retail sales growth in July as being the best in three years. But public sector lay-offs, spending cuts and tax rises will inevitably take their toll on growth. Nobody expects the economy to continue expanding at the same speed it achieved between March and June. That means risks for the pound.

The euro managed to dodge the bullets after the EU published the results of 'stress tests' on 91 of Europe's biggest banks. All but seven of them passed the test, which examined how they would stand up to another recession. In one way that was clearly a good thing; the vast majority of European banks would remain solvent in a worst-case scenario. What concerns some investors is that the 'worst case' did not look particularly horrible. While the Spanish test included, for example, a -26% fall in property values, the Greek test was much more gentle with a -2% decline. Austria's model looked more like a best-case scenario with house prices rising by 2.7%.

Yet the results were broadly good and it is in nobody's interest to make adverse comment about the emperor's new clothes. A month ago sterling/euro was about to touch its highest level since November 2008. Now it is trying to decide whether it would rather stay below €1.20 or head back for another look at last month's high. It could go either way but there is still a sensation that the pound, armed with a tough budget and reaffirmation of its AAA credit rating, has the potential to recover more of its losses sooner or later.

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