by Adam Solomon
Sterling / Euro and US Dollar
The Pound failed to receive a boost against the majors, after the Bank of England decided to keep interest rates unchanged at a record low of 0.5%. The UK currency remained just above 1.64 versus the Dollar and 1.12 against the Euro before the ECB press conference. The central bank also kept interest rates on hold this month but in the accompanying statement, the chairman Jean-Claude Trichet, gave a strong indication to the market that the governing council will be raising the benchmark lending rate in July.
His hawkish rhetoric on inflation was followed by the key term that “strong vigilance” is required in order to maintain risks to price stability. Trichet has historically been very transparent on the ECB’s monetary outlook and the Euro has been gaining for the past week on speculation that the central bank would increase interest rates to 1.25% in July.
Therefore, the Euro hasn’t rallied to a degree that one might expect following the statement, largely because a rate increase has been factored into the market and that is the primary reason the Euro has gained versus the Pound for the past six days consecutively. However, given the inherent weakness in Sterling and the negative sentiment engulfing the UK economic outlook, the Euro may stage a move towards 1.10 over the coming days to test the support level from the previous downside move.
The single currency also had a subdued response against the Dollar following the statement, trading back towards 1.4450 overnight. The downward movement on EUR/USD also saw the U.S Currency strengthen towards 1.63 versus the Pound, indicating that the Euro’s incredible rally over the past two weeks was over-exaggerated and we’re witnessing a correction in the market.
The Bank of England left interest rates unchanged at 0.5% and investors will have to wait until the minutes of the meeting are released later this month to gauge how the MPC voted in June. Recent economic data has pointed to a loss of momentum in the recovery and policy makers are focused on supporting growth rather than tackling inflation.
The BoE also left its bond purchase program on hold at £200 billion and Mervyn King’s push to maintain low interest rates won the support of the IMF this week, which said it’s appropriate to maintain the “current scale of monetary stimulus.” While inflation is more than double the government’s 2% target, support for higher interest rates has been eroded by Andrew Sentance’s departure in May, exactly a year after he first called for higher rates.
The UK economy stagnated in the six months through March, barely erasing the contraction in growth from the fourth quarter of 2010. Consumer spending slumped by the most in almost two years in the first quarter and surveys last week pointed to further weakness, as manufacturing expanded at the slowest pace in 20 months in May and services growth cooled.
According to the sterling overnight interbank average, investors are now betting on a 25 basis point increase in UK interest rates in April next year and that forecast is being scaled back almost on a weekly basis, undermining confidence in the Pound. The IMF has lowered its 2011 UK growth forecasts this week to 1.5% and Moody’s Investors Service has warned that the UK could be subject to a credit rating downgrade if the government fails to meet its deficit reduction target this year.
The Pound also came under pressure yesterday amid further uncertainty surrounding the UK growth forecast and the overall tone was pessimistic. In terms of economic data, the UK trade data was marginally better-than-expected with the deficit for April £7.4 billion and there were still some expectation that the economy can secure strong growth through rising exports.
The Pound rallied to a high of 1.13 against the Euro exchange rate yesterday, before contracting later in the day, after Trichet’s comments spurred speculation that the ECB won’t raise interest rates as quickly as previously forecast. The UK currency bounced back from a one-month low against the Euro, despite Trichet’s indication that Europe will lift rates in July, as the rest of his speech was surprisingly negative.
The Pound is trading lower against the Euro and a basket of currencies this morning, before a report that is expected to show a drop in manufacturing output in April. Other data of note today includes producer price inflation, which is expected to show that factory prices receded, further adding to the argument to keep interest rates on hold.
Euro / US Dollar
The Euro exchange rate spiked higher against the Dollar at the start of the ECB press conference yesterday before retreating sharply following mixed comments from the chairman Trichet. The single currency is poised to record the first weekly drop against the Dollar in a month, as investors speculate on how aggressively policy makers will raise interest rates this year.
The Euro traded lower against 10 out of the 16 most actively traded currencies, as concerns over sovereign debt resurfaced in the wake of Trichet’s statement. He rejected calls for the central bank to bailout Greece and his largely dovish rhetoric undermined confidence in the Euro to a degree where the single currency slumped almost 2% versus the U.S Dollar.
The Dollar and Yen also benefited from the uncertainty surrounding global financial markets in the wake of Trichet’s comments. The revival in risk aversion saw a flock to safety during the Asian trading session overnight, as traders moved away from higher-yielding assets in favour of the safe haven currencies.
U.K 09:30 – Industrial Production (April) – Manufacturing Output
U.K 09:30 – Producer Price Index (May) – Output
U.K 15:00 – NIESR GDP Estimate (3 Mths to May)
U.S 13:30 – Export / Import Prices (May)
U.S 19:00 – Federal Budget (May)