by Adam Solomon
Sterling / Euro and US Dollar
The Pound initially declined against the Euro and the US Dollar yesterday, after a report from the Office of National Statistics showed that UK inflation remained unchanged at 4.5% in May. The result matches the fastest pace of inflation since October 2008, but the Bank of England are still unwilling to tighten monetary policy and risk jeopardising the economic recovery.
MPC member Martin Weale reiterated calls for higher interest rates to combat the relentless pace of inflation and the committee are split three ways on the best course of action. The IMF supports the Bank’s accommodative policy on interest rates and the government can’t falter in the deficit reduction plan or Moody’s will downgrade the UK credit rating.
The Bank of England left interest rates unchanged at a record low of 0.5% last week, amid concerns that officials need to support growth over tackling inflation, which is more than double the government’s 2% target. Martin Weale, who has voted to raise interest rates for the past three months, said that there’s a substantial risk than inflation will accelerate to more than 5% this year.
The Pound rallied back towards 1.64 against the Dollar after the data, primarily due to the overall improvement in risk appetite. The inflation data failed to generate any positive impact on the Pound because no matter how fast inflation accelerates the Bank of England will not raise interest rates in the current economic climate.
The economic data released for the second quarter has been subdued to say the least and there is an inherent risk that the recovery stalled in the three months to June. The UK economy barely grew enough in the first quarter to erase the previous quarter’s contraction and the anaemic pace of growth will spur speculation over a second recession.
Retail price inflation, a measure of the cost of living used in wage negotiations, also remained unchanged from the previous month. Higher energy and raw material costs have put increased pressure on consumer spending and it is highly likely that the headline rate of inflation will breach the 5% barrier at some point this year.
In the Bank of England’s quarterly bulletin released earlier this week, the chief economist Spencer Dale said that while consumers outlook for inflation “remains reasonably well anchored” public satisfaction “with the way in which the bank has set interest rates to control inflation has declined since the middle of 2010.”
The Pound recovered the losses through the course of the day, rising back above 1.64 against the Dollar and 1.1350 versus the Euro. The Dollar weakened after a report showed that retail sales fell less-than-expected in May, reducing the appeal of the U.S currency as a haven and boosting traders’ appetite for riskier assets.
The Pound also pushed higher against the Dollar and the Euro, after a report last night showed that UK consumer confidence rose the most in almost six years in May. The data is somewhat of an anomaly given the recent trend and it does indicate that the pick-up in spending during in April was largely due to the extra public holidays and Royal wedding.
An index of consumer sentiment gained 11 points to the highest level in five months and that represents the biggest monthly increase since November 2005. However, UK inflation is outpacing wage growth and squeezing households’ disposable income. The government’s public spending cuts will also impact on confidence and a report this morning is expected to show that average earnings rose 2.1% in the three months through April.
Euro / US Dollar
The US Dollar exchange rate weakened against the majority of the 16 most actively traded currencies yesterday, as the smaller drop in retail growth spurred demand for higher-yielding currencies. The better-than-expected retail numbers follows subdued reports on manufacturing and rising unemployment. The data supports suggestions that the U.S economic recovery will be slow and protracted this year, with the prospect of further quantitative easing looming in the distance.
The Euro exchange rate found support in the region of 1.4410 against the U.S Dollar and pushed to highs near 1.45 following the data. The Federal Reserve Chairman Ben Bernanke warned that the U.S Aaa credit rating could be at risk if there is no improvement in the fiscal position and underlying confidence in the economy remains fragile.
The Greek debt situation still remains an important focus, as EU finance ministers battle to find a workable solution during an emergency meeting. The German government continued to insist that private bond-holders would need to accept losses as part of any fresh support package to Greece. The ECB are opposed to any plans to restructure Greece’s debt, as it would be considered a default by credit ratings agencies.
The uncertainty surrounding sovereign debt in the Euro-zone will be a negative factor for the Euro, especially if there are any suggestions that a fresh support package could be delayed. The Euro declined for the first time in three days against the Dollar this morning, as the single currency lost 0.5% to 1.4362 overnight. The focus today will fall on the U.S inflation data with consumer prices expected to increase modestly at the slowest pace in six months.
U.K 09:30 – Claimant Count (May) – ILO Unemployment
U.K 09:30 – Average Weekly Earnings (April)
EU 10:00 – Industrial Production (April)
U.S 13:30 – Consumer Price Index (May) – Ex Food Energy
U.S 13:30 – Real Earnings (May)
U.S 13:30 – NY Empire State Manufacturing Index (June)
U.S 14:00 – TICS Capital Inflows (April)
U.S 14:15 – Industrial Production (May)
U.S 15:00 – NAHB House Builders’ Sentiment (June)