“An increase of interest rates in the next meeting is possible.” So spoke Jean-Claude Trichet at the ECB’s press conference earlier today. This, and similarly hawkish comments throughout the conference, have brought forward market expectations for an ECB rate rise by five months! The market now expects to see the ECB move the base rate from 1.00% to 1.25% at their meeting in on April 7th.
As detailed in my previous blog-post there were rumours that Trichet would be overtly hawkish in calling for the inflationary pressures to be quashed. He did not disappoint. Indeed he went above and beyond expectations stating that “strong vigilance” is required.
The upshot of all this? The euro has had a storming day! Against all 16 of its major counterparts the single currency has climbed, hitting a fresh four month high versus the US dollar at $1.3974, breaking strong resistance at $1.3950. It has also put the sterling price back to 1.1650.
The reasoning behind this sharpened rhetoric from Trichet comes from higher inflation, stemming from rocketing oil prices (and other commodities), which have pushed inflation levels above the ECB’s 2% target.
Adding to sterling’s woes, the pound stumbled following a disappointing reading of activity in the UK services sector, undoing the improved sentiment seen earlier in the week off the back of positive manufacturing and construction data.
The services PMI index fell to 52.6, down from an 8-month high of 54.5, underperforming market expectation.
Although the figure doesn’t exactly signal Armageddon (all key industries are still in expansionist territory), weak fundamentals and jitters about the stability of the economy will leave the pound vulnerable to investors paring back their expectations for an interest rate hike.
So what does this all mean going forward? I fear that we have may seen a game changing statement today. Sterling’s prospects against the euro do not look nearly as healthy as they did yesterday. We still feel that further upside against the US dollar is due, though this move will likely be one of dollar weakness. Downside risks for sterling/euro have swung into view…
Ewdard Knox
Analyst - Caxton FX
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