by Adam Solomon
Sterling / Euro and US Dollar
Following on from last week, the Pound rallied modestly against the Euro as the Bank of England kept interest rates on hold at 0.5%, while Portugal’s request for financial assistance weighed on demand for the single currency. The outcome of the BoE interest rate announcement was widely anticipated but next month the MPC will know how the economy performed in the first quarter of the year and whether the recovery is strong enough to incorporate an increase in borrowing costs.
With inflation currently at 4.4%, more than twice the government’s target, it is clear that the BoE will raise interests rates at some stage over the coming months and speculation will intensify of the timing of any potential increase. The European Central Bank pressed ahead and increased its benchmark lending rate by 25 basis points, the first rate hike in almost three years. The renewed concern over the structural vulnerabilities in the Euro-zone following Portugal’s bailout request has taken some of the positivity away from the rate increase.
In the accompanying press conference, the chairman Jean-Claude Trichet indicated that the governing council was still undecided about further rate increases and the absence of a hawkish rhetoric also undermined the Euro. Money markets anticipate two further rate hikes over the course of the year, but the focus may now switch to the Bank of England and the possibility of a May increase.
The Pound had strengthened 0.8% against the Euro last week, as economic data suggests that the UK economy has recovered from the fourth quarter contraction. Reports last week have showed that UK house prices rose in March after dropping 0.9% the previous month, while UK service sector growth expanded at a faster pace than anticipated.
According to forward rates on the Sterling overnight interbank average, investors have priced in a 25 basis point increase in UK interest rates by July. The Pound’s performance against the majors this month will be largely data dependent, as policy makers look for signs that the economy is growing despite the austerity measures and geo-political issues at work.
Many analysts are of the opinion that the Pound should recover against the Euro as speculation instensifies over the timing of a rate increase, while the UK currency also looks poised to make further gains against the weak U.S Dollar. Although UK inflation has accelerated to the fastest pace since November 2008, the BoE still believe that the recent increase is due to external factors and have shown a real reluctance to risk dampening the recovery with a token 25 basis point increase.
The Pound continued to rally against the ailing Dollar, despite a drop in global stocks following reports that Japan was hit by a 7.1 magnitude earthquake towards the close of trading on Thursday. The benchmark FTSE 100 Index lost 0.6% on the day, reducing traders’ appetite for riskier assets. Stocks had gained for the majority of the day, after Portugal requested a bailout from the EU, creating optimism that Europe’s sovereign debt crisis will be contained.
The Pound rallied to 1.6406 against the U.S Dollar overnight, as global risk appetite continued to improve and reduce the appeal safe haven assets. The UK currency traded at its strongest level since January 2010, as a report from the Office of National Statistics showed that producer prices rose at a faster pace than initial forecasts.
The so-called factory gate inflation increased 0.9% from February, above the 0.6% median estimate, and the report will fuel concerns surrounding persistently high inflation and emphasise the need for higher interest rates. The Pound, however, lost further ground against the Euro, despite Portugal requiring a financial bailout from the European Union, after German exports rose to the highest level in five months.
The focus this week will fall on the latest consumer price index on Tuesday and considering the ongoing speculation over the timing of a rate increase, the result of the data will be watched closely. The headline rate of inflation is expected to remain unchanged at 4.4% last month, more than double the government’s target.
Core inflation rates are also expected to remain elevated ahead of the release of the first estimate of gross domestic product in the first quarter. Elsewhere, the latest UK unemployment data is expected to show that the jobless rate remained high at 8%. The average earnings component of the report will also be watched for any signs of inflationary effects.
Euro / US Dollar
The Euro slumped from its highest level in more than a year against the U.S Dollar, after the European Central Bank President Jean-Claude refused to be drawn on whether Thursday’s quarter-point increase will be the first in a series of rate hikes this year. It is unlikely that the central bank would raise interest rates just once to combat inflation, but the lack of hawkish sentiment has hurt the Euro.
The Euro declined against 14 out of the 16 most actively traded currencies, despite the first rate increase in three years, because the market was anticipating an indication of a May increase. The Euro has gained almost 7% against the U.S Dollar this year on interest rate speculation, but we may have reached a near-term high against the Pound and the U.S currency.
Trichet told reporters at a press conference in Frankfurt that “we did not decide that it was the first of a series of interest rate increases. We will continue to do in the future what is appropriate to ensure price stability.” The subtle change in language indicates that policy makers won’t be raising rates again in May.
The Dollar was, however, unsettled by reports of Asian Central Bank diversification away from the U.S currency and budget negotiations remained an important factor during the day on Friday. Despite a provisional agreement on spending levels, there was no agreement before the end of trading.
At this stage, money markets are expecting the Federal Reserve to shy away from further quantitative easing but will also keep interest rates at ultra low levels for an extended period. The main data released this week are likely to be the U.S retail sales and consumer prices for March. Sales are expected to remain relatively strong, while inflation probably accelerated last month due to higher energy prices.
U.K 00:01 – BRC Retail Sales Survey (March)
U.K 00:01 – RICS Housing Report (March)