As sterling recovers, US dollar weakness to persist

Sterling suffered a disappointing end to the week after Britain’s 4^th quarter economic growth was revised down from -0.5 to -0.6%, seemingly ruling out the possibility of a near term rate rise. However, the markets seem to recognise that the end of Q4 represented a highly unusual environment at the mercy of terrible weather conditions and in trading today the pound has bounced off its lows.

The market will now focus on the key UK data releases this week in the form of construction, services and manufacturing monthly PMI figures. If January’s rebound is replicated in February, a sterling/euro uptrend seems probable. However, ongoing concerns over the UK housing market and fears that the government’s austerity measures could stifle the recovery are likely to keep the pound pegged below €1.20.

Just as UK fundamentals are looking fragile, so too is the case in the eurozone. This is particularly the case given Fine Gael’s victory in the Irish general election, as the party may now look to renegotiate the Irish bailout terms. Nonetheless, ongoing interest rate speculation has focused on the ECB of late, following increasingly hawkish tones from certain policymakers. The prospect of an early ECB rate hike gained credibility today as eurozone CPI reached a 27-month high fuelled by soaring oil prices; a trend that shows no signs of relenting in the near-term. 

The net result is that we do see the pound gaining steadily against the euro in the short term, although another push for €1.20 still looks some way off. Against the US dollar however, both the pound and the euro could have further near term upside.

The dollar’s fall across the board looks set to continue as US Federal Reserve Chairman Bernanke is expected this week to maintain his dovish stance on US monetary policy, largely driven by stubbornly high unemployment. Investor attention will be fixed on US Non-Farm employment figures published Friday. Regardless of the reading we still feel that any talk of a rate rise from the Fed is hugely premature but a solid figure could raise questions about whether QEII will remain in place through the end of June (as originally intended). The usual amount of hype preceding the labour market figures will probably met with a traditionally apathetic response from the market.

At this stage it seems that there’s little that will deviate the market from its current sentiment toward the US dollar. We might reassess this thinking if socio-political tensions spread to Saudi Arabia....!

Duncan Higgins
Analyst - Caxton FX

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Pound down as GDP revision adds further woe

As suspected – revision of our GDP figure was less than positive (quite literally) as official data showed today that underlying growth was marginally weaker than previously thought in Q4, having been revised down to -0.6% from -0.5%.

The figure will add further credence to the 6 dovish leaning members of the MPC, who wanted to wait and see how the economy faired before jumping in to vote for an interest rate increase, but what will the implications of this be?

The market reaction saw the pound fall further across the board, reaching a month low versus the euro as traders took advantage of the figure and liquidated their long sterling positions. They now have to assess whether this dip in growth will change the prospects for the interest rate outlook.

It’s unlikely that a figure from last year will have too much bearing on rate expectations, particularly as Q1 2011 has gotten off to a solid start. Andrew Sentance et al I’m sure will merely shrug this figure off and put it down to snow-related disruptions. Traders have however pared back expectations for a 25 basis-point increase from May to June.

We now look forward to another busy week. Highlights include Britain’s PMI figures across the manufacturing, services and construction sectors due on consecutive days mid-week. After January’s positive results, (which lent a helping hand to the pound), we could well see further positive figures this month, buoying hopes that the economy will return to growth in the opening quarter of the year. We also have three central bank announcements on the calendar: the Reserve Bank of Australia , Bank of Canada and European Central Bank. However, no changes are expected.

The week’s headline comes right at the end in the form of US non-farm payrolls. Each month the hype in the market gets inflated as the release approaches, but more often than not price action is underwhelming. Nonetheless, US non-farms nearly always bring about an excitable market – no let up volatility approaching just yet.  

Any thoughts or comments are always welcome!

Edward Knox

Analyst - Caxton FX

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Uncertainty is certainly harming pound

Markets dislike uncertainty, and that is the only certainty in the markets right now – this seems to typify market action over the past few days, as we head towards the end of a topsy-turvy week.

Sterling has had a rather unimpressive day, falling sharply against its counterparts on the back of a broad rise in risk aversion. A spike in the price of oil as tensions mount in the oil rich Middle East and North Africa is driving investors to safe haven currencies with the Japanese yen and the Swiss franc the outperformers at present.

The pound has rallied since the start of 2011 on the back of higher inflation and heightened speculation that the BoE will raise rates sooner than most. However, it seems that after the release of yesterdays minutes investors may well be reassessing the state of the UK economy and asking themselves whether monetary tightening will threaten the UK economy’s fragile recovery.

Arch hawk Andrew Sentance is certainly of the opinion that raising interest rates is the way forward, as was detailed in my recent blog post.  The increased hawkishness in the MPC camp, led by Sentance, has been supportive for the pound in recent times, however he is due to leave the MPC in May. So what effect will this departure have on the BoE’s stance? Vicky Pryce, one of the candidates to succeed him, pointed out the risks of raising rates too soon in a column this week – this won’t sit too well with investors who have already priced in an imminent rate hike.

David Miles also added to sterling’s woes in the short term, announcing yesterday evening that the best way to control inflation would be to “raise interest rates gradually,” contradicting Sentance’s argument that there should be an immediate rise of 0.5% in the base rate.

Uncertainty over the prospects for the UK economy and the evident dilemma facing the Bank of England looks set to keep sterling choppy. We will now look forward to the GDP revision tomorrow morning (first estimate -0.5%) – something tells me that we will be in for a rather underwhelming figure. Even a small upward revision would still leave the economy in contractionary territory, and is unlikely to prove the catalyst for renewed sterling strength. 

Edward Knox

Analyst - Caxton FX

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Minutes revealed to muted reception

So, as the market had more or less anticipated, a third MPC member has jumped on the hawkish bandwagon. In the BoE minutes, released today, it was revealed that Spencer Dale was the latest member to recognise the threat of rising inflation, throwing his hat in the ring with arch hawk Andrew Sentance and Martin Weale in voting for an immediate interest rate rise.

Much of this had already been priced into the market as analysts deciphered clues from speeches given throughout the last few weeks; in particular Mervyn King’s acknowledgement last week that there was an unusually diverse array of opinions amongst the Committee.

Perhaps then the market was slightly underwhelmed when the results showed a 3-6 split, with sterling briefly enjoying a knee jerk boost before dropping back again against the euro. The pound did however enjoy a rally against the US dollar as the minutes firmed opinion that the Bank of England will raise rates sooner than the Federal Reserve on the back of inflationary pressures, which partially offset ongoing concerns about political tensions in the Middle East and North Africa.

The minutes also revealed that Sentance on this occasion stuck his neck out and ramped up his argument that inflation poses a far bigger risk than the bank is willing to recognise by voting for a 0.50% increase in the base rate as opposed to the more traditional 0.25%. The standard pre-release rumours had covered this eventuality so again there wasn’t too much made of his vote and it’s unlikely to prove any more of a compelling argument for those policymakers still sitting on the fence.

With the hype and drama of the minutes now passed the market’s focus will shift to Friday where the UK’s second estimate of fourth quarter GDP is due. At an initial estimate of -0.5%, most are hoping that there may be an upward revision. However, even if there is it is unlikely to be greater than a factor of 0.2%, leaving the figure in contractionary territory, much to the discomfort of sterling bulls who appear to be losing their preeminent position!

Edward Knox

Analyst - Caxton FX

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Middle East crisis overshadows MPC minutes

With tensions in the Middle East reaching fever pitch, we’ve finally seen the market react today. Investors have lined up to put their money in safer assets on the back of the geopolitical risks with the US dollar, Swiss franc and Japanese yen all benefitting from the global uncertainty.

Libya, the latest in a string of countries across northern Africa and the Middle East to revolt against its oppressive regime in recent times, is teetering on the edge of civil war as Muammar Gaddafi, the tyrannical ruler, desperately clings to power saying that he will fight “until the last bullet” - a phrase which I’m sure won’t sit well with the protesters looking to give their country the progress it needs after decades of mismanagement.

The pound fell against its safe-haven US counterpart today as investors sought to hedge the risk of a potential fall-out from Libya. The pound gained against the euro in early trading on the back of this US strength, however ceded its gains on the back of hawkish comments from ECB policy maker Yves Mersch. Mersch said that he would not be surprised if the bank “sharpened its tongue on inflation”.

The comments saw a huge swing in the euro’s favour perhaps alerting the market that there are indeed big decisions to be made on interest rates after the news of the unrest in the Middle East quite rightly stole the headlines.

The ECB is still expected to trail the Bank of England in raising interest rates, but Mersch’s comments have certainly done the euro no harm. The gains come despite concerns raised by the Bundesbank Governor and one time ECB president candidate Axel Weber, who fired a parting shot at the ECB’s bond purchasing programme on the same day that it was revealed that they bought 24% of Portuguese debt in the auction 2 weeks ago.

Despite waning enthusiasm for the pound off the back of falling risk sentiment, the market will now be gearing itself up for the results of the MPC’s minutes which will be revealed tomorrow. 

Edward Knox

Analyst - Caxton FX

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Sentance gives sterling a boost

It seems that this interest rate saga is keeping the market on tenterhooks, with a new twist hitting the headlines this morning. In a nice follow up to my recent blog, the story continued today as Andrew Sentance, a resident hawk in the MPC, more or less rebuffed Governor King’s speech which claimed that the market was “getting ahead of itself” in anticipating an interest rate hike.

In response sterling recouped some of its losses from yesterday, up against most of its major counterparts as Sentance slammed the Central Bank’s economic forecasts, accusing them of understated inflation risks. In his most outspoken attack yet, Sentance made clear his view on the Central Bank’s poor track record in forecasting inflation, and suggested that monetary policy would most likely need to be tightened faster and “more than the markets currently expect” to combat record inflation.

Sentance argued that raising interest rates would bolster the value of the pound, which would help to offset the rising cost of imported commodities – a key contributing factor to the doubling of the banks inflation target.

Although this morning’s comments will no doubt have offered support for sterling, the underlying problems of high unemployment and low real wages may well be reflected in tomorrow’s retail sales data. The market then will now look forward to the MPC minutes, which will be released on Wednesday with baited breath: will we see a third vote in favour of a rate rise? Not just yet would be my guess.

Edward Knox

Analyst - Caxton FX

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Sterling dives on dovish sentiment

Britain’s Consumer Price Index came out yesterday morning with the news that inflation is indeed at 4% - confirmation that inflation is now double the Bank of England’s target rate of 2%.

Having received the news that inflation had hit a 2 year high, and with traders anticipating a near-term interest rate hike, the pound duly rallied across the board.

Today was however a different matter. In a press conference this morning to discuss the recent inflation data, King was typically downbeat on the prospect of raising rates, cooling market expectation with his dovish tone. He alluded to the idea that the Bank may well keep interest rates at a record low to aid the recovery which is “unlikely to be smooth”. He followed this up with clarification that policy makers haven’t actually preannounced an interest-rate increase, suggesting that the market may have “run ahead of themselves”.

The bank today forecast that inflation will quicken from a 2 year high and peak at 4.4% before easing to its 2% target in mid 2012. This came amongst downgrades on its growth forecast.

On this news, an already twitchy market saw the pound fall against all of its major counterparts.

Some in the market then will reconsider whether UK rates will rise as early as mid-year. We will see a fuller picture when the bank releases the minutes from its recent inflation report meeting next week. The MPC members have a tough job in balancing higher inflation with weak economic growth, with King rightly acknowledging that “if you don’t see differences of view in this kind of situation, when ever would you find them?” What is certain, is that the BoE will have to raise interest rates at some point, the market will now however have to reassess when they will pull the trigger with King giving no hints away on timing.

Edward Knox

Analyst - Caxton FX

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Eurozone cracks begins to show

After England’s demolition (yes I think we can go that far) of Italy at the weekend, the theme continues in the currency markets, with the pound rallying against its euro counterpart, climbing up .70% on the day and briefly touching €1.19.

After a lengthy absence from front page news, the eurozone cracks are finally beginning to re-appear, with a plethora of potential problems hitting the headlines once more.

The lack of news coming recently, coupled with euro strength had more or less duped investors into thinking that they had put the eurozone troubles behind them. This is not the case however, as Ireland and Greece reared their ugly heads with signs that all is not well in their respective camps.

Ireland’s main opposition party, Fine Gael, announced today that they would seek a renegotiation of the international bailout that Ireland received should they be elected on February 25^th. Meanwhile Greece, in a sign that they may be struggling to match debt repayments, criticised the IMF and European Union for the stringent terms that were imposed on them.

This comes on the same day that Portugal, (another member of the G.I.P.S.I. family) saw benchmark government debt yields climb to an all time high, above the psychological 7.00% barrier, to 7.37% - a bad sign for the countries borrowing costs. This raises the prospect that the country may yet be forced to appeal for a bailout.

In other news, reports suggested that rescue plans for ailing lender WestLB were under threat, assuring that euro sentiment remained sluggish at best at the beginning of this week.

The main driving force behind the currency markets, EUR/USD, broke below key technical support on this news, and continues to fall with little light at the end of the tunnel in the near term.

A frenetic start then to a busy week – focus has returned to the eurozone with Spanish and Italian bond auctions, and German GDP all still awaited. Meanwhile Britain’s inflation report on Wednesday is looking to overshadow the whole lot as Mervyn King takes the stand.

Edward Knox

Analyst - Caxton FX

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Sterling bulls return for a busy week ahead

Strong PPI data from the UK was largely ignored by the market today, with the pound waning as investors look for clarity after the Bank of England decided to keep interest rates on hold.

Clarity will surely come next week, when the BoE releases its quarterly inflation report which will include their projection for inflation and economic growth over the next 2 years.

Mervyn King, the Bank of England Governor, maintains that inflation is being driven by one off domestic factors such as the rise in VAT, and external factors over which the bank has no control such as spiralling commodity prices, but the market has already priced in an interest rate rise as the fear begins to set in that inflation is becoming entrenched.

Next week could then be a tale of sterling strength amid an extremely busy calendar. The UK’s latest inflation figures are also due on Tuesday and with a forecast of 4.1%, the hawkish policymakers are sure to have the upper hand.

In the eurozone, preliminary GDP figures are released for Europe’s powerhouses, France and Germany. If Britain’s weather afflicted GDP figure was anything to go by, we could be looking at some euro weakness as the readings undershoot expectations.

Other highlights for the week will include the publication of the minutes to the Feds latest meeting. The report is likely to strike a dovish tone with the statement following the meeting a couple of weeks ago reiterating the need to keep monetary policy ultra loose in order to accommodate a recovery in the labour market. The problems surrounding high levels of unemployment appear to be hindering the hawkish mentality of the two most recent additions to the committee.

Despite the pound’s momentum petering out slightly towards the end of this week, I wouldn’t be surprised to see the sterling bulls return as speculation for a rate rise turns to March.

Edward Knox

Analyst - Caxton FX

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UK interest rates on hold

So, despite a build up of speculation to the contrary, the Bank of England’s Monetary Policy Committee decided to keep policy unchanged today, leaving UK interest rates on hold at 0.5%.

Sterling briefly touched a session low against the USD following the decision as hawkish traders rather optimistically priced in a 20% chance of a rate hike. The pound has since recouped its losses with the expectation gaining momentum that the BoE will indeed tighten monetary policy to counteract the rising inflation.

Even amid stronger economic figures, notably from the National Institute of Economic and Social Research (NIESR) which suggested that UK economy grew by 0.6% on the month in January, evidence of a sustainable recovery is still thin on the ground, with the economy facing headwinds from some heavy public spending cuts.

The full outcome of the meeting won’t be known until the minutes are produced in a fortnight; it will be interesting to see whether any of the 6 members currently sitting on the fence decided to take sides, with the pressure to act amid growing inflationary fears certain to have induced some fairly heated debates.

Although the government will undoubtedly be content that the bank decided to hold fire on rates – cushioning the blow on their fiscal tightening  - the same may not be said for sceptics of the BoE, whose line on inflation being temporary is beginning to wear thin a year down the line.

The pressure cooker is well and truly on then; a rate hike is more or less inevitable by May according to the latest consensus.

Edward Knox

Analyst - Caxton FX

For the latest forex news and views, follow us on twitter @caxtonfx and sign up to our daily report.