by Adam Solomon
Sterling / Euro and US Dollar
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.
However, the Pound slumped for the first time in five days against the U.S Dollar, but remained within a cent of a two-week high. 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 their 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 has strengthened 0.8% against the Euro over the past five trading days, as economic data suggests that the UK economy has recovered from the fourth quarter contraction. Reports this 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 intensifies over the timing of 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 last night. 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 rose to a high of 1.6406 against the U.S Dollar in overnight trading, as the focus this morning will on a measure of UK factory gate inflation. Producer prices are expected to accelerate beyond February’s headline figure, further emphasising the persistent inflationary concerns within the economy and the need for higher interest rates.
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 yesterday’s quarter-point increase for be the first in 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 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.
U.K 09:30 – Producer Price Index (March)