by Adam Solomon
Sterling / Euro and US Dollar
The Pound declined against the Euro yesterday, after a report from the Office of National Statistics unexpectedly showed that UK industrial production declined in February. Over the past quarter, the improvement in manufacturing output, due primarily to a weak Pound, has been the cornerstone of the economic recovery, but the report will fuel concerns that the route back to growth will be a bumpy one.
Manufacturing output dropped 1.2% from the previous month, despite initial estimates of a 0.4% increase, while reports earlier this week revealed that UK service sector growth expanded way beyond forecasts. The result will dampen speculation of an increase in UK interest rates with the Bank of England very unlikely to raise rates this lunchtime having waited all of this time for the first quarter GDP numbers.
The manufacturing data had an impact on the Pound’s recent momentum and there are some suggestions that the Bank of England will keep interest rates on hold at a record low of 0.5% until November. The UK currency weakened 0.6% against the Euro yesterday and 0.1% higher versus the U.S Dollar, after reaching the strongest level since March 23rd.
The overall improvement in risk appetite continues to undermine Dollar sentiment and the Pound also took advantage of a report from the Halifax, which showed that UK house prices rebounded in March. The Pound has fluctuated between 1.60 and 1.64 against the Dollar for the past two months, as investors speculate on the timing of a potential rate increase and the subsequent impact on the economic recovery.
The focus this month will be on GDP report and a strong return to growth in the first quarter would prompt widespread speculation a rate hike as early as May. That would be very supportive to the Pound and potentially move the market back towards 1.18 versus the Euro. Reports overnight that Portugal will seek a bailout from the European Union helped the Pound move back above 1.14 ahead of the midday announcements.
There was a strong reading in the latest GDP estimate for the first quarter, which maintained expectations of a strong recovery from the fourth quarter contraction. The report from the National Institute of Economic and Social Research showed that gross domestic product increased to 0.7% against expectations of 0.6%.
Near-term attention will tend to focus on the Bank of England’s monetary policy decision, especially since the latest services data increased pressure for higher interest rates, while inflation continues to accelerate. There is likely to be an increased period of volatility following the announcement, but the Pound may struggle to extend gains versus the Euro, with the ECB expected to raise interest rates to 1.25%.
Euro / US Dollar
The Euro took advantage of broad Dollar weakness yesterday, surging to the highest level in more than a year, amid speculation that the European Central Bank will increase borrowing costs further this year, after giving a strong indication of a rate hike today. The single currency shrugged off reports that Portugal will seek financial aid from the EU, joining Greece and Ireland, as it failed to meet its 2010 deficit reduction target.
It is thought that a much anticipated bailout of Portugal will not threaten the stability of the Euro-zone and will not prevent the ECB from raising interest rates through the course of the year. The chairman Jean-Claude Trichet refuses to be drawn on suggestions that policy makers will embark on a series of rate increases, but given the strength of the Euro, the market doesn’t give too much credibility to this statement.
The Dollar declined to a record low against the Australian Dollar and also traded at the lowest level in three years versus the Canadian Dollar, amid speculation that the Federal Reserve will trail other central banks in tightening monetary policy. Asian central banks have also been aggressively preventing upward pressure on their currencies over the past week and a natural result from this is likely to be further reserve diversification away from the U.S Dollar.
GER 11:00 – Industrial Production (February)
U.K 12:00 – BoE Interest Rate Announcement
EU 12:45 – ECB Interest Rate Announcement
EU 13:30 – ECB Press Conference
U.S 13:30 – Weekly Jobless Claims (w/e 26th March)
U.S 20:00 – Consumer Credit (February)