Foreign Exchange Market Overview

Wed, March 02, 2011

The UK's Purchasing Manager Index (PMI) for the manufacturing sector showed that activity improved at a faster pace than was expected by economists. Coupled with January's mortgage approvals increasing beyond expectations, the outcome meant that the British Pound rose against the US Dollar to post a fresh high of 1.6329, the highest exchange rate for the currency pair to be seen for 13 months.

Compared to Tuesday, Wednesday's docket is looking thin on the ground for UK figures, but of the data to be released, the Halifax house price survey was expected to show that the value of UK homes has fallen in the 3-months up to February, however given that Tuesday's Nationwide house price survey reported a more marginal decline than was expected, it wouldn't be a remote possibility to expect a similar outcome. Still falling house prices are likely to weigh on the Pound. Later into the session February's PMI for the construction sector is scheduled for release, and should the report show that construction activity gathered pace since January's reading, then this will lend support to the Pound.

The Euro held a narrow trading range against the US Dollar and the British Pound throughout Tuesday, despite inflationary forecasts for February coming in at 2.4%, which is above the ECB's inflationary target of "below, but near to 2%". Following yesterdays better than expected German unemployment figures, the unemployment rate for the Euro-zone fell from 10.0% to 9.9% in January. The data meant that at its peak, the Euro traded at 1.3854 against the US Dollar and 1.1755 against the British Pound.

Similar to the UK, there is little economic data to be reported from Europe today other than January's producer price index, which is expected to grow at a faster pace than recorded in December. This will add to the already mounting inflationary pressure that is expected to make the ECB more open to raising the interest rate, as increased costs incurred by producers are often passed onto the consumer in the form of higher prices. Since the Euro exchange rate has been supported by rate hike expectations, it is possible that today's data could push the currency higher.

According to yesterday's ISM Manufacturing report figures hit its highest reading in nearly 7 years. The increase surprised economists who expected that the pace of activity would slow from January into February. In his testimony to the Senate Committee, Federal Reserve Chairman Ben Bernanke stated that that he believed rising commodity prices would only provide a temporary elevation in consumer prices, downplaying the nation's risks to inflation. Bernanke held the view that economic growth will accelerate as the year unfolds, and defended the Fed's $600 billion Treasury purchase program as job growth remained weak and unemployment was relatively high.

US figures for this afternoon will focus on the nation's employment situation with February's ADP Employment Change forecast to print a slightly lower reading than January's report; however should the survey reveal that private sector job growth improved beyond expectations then the US Dollar is likely to find support. The Fed's Beige book economic survey is due out for release at 19:00 GMT. If the beige book suggests that the economic situation for each of the Federal districts is improving then the Dollar is likely to appreciate.

Perhaps the biggest issue for the US is whether or not lawmakers will be able to avoid a shutdown of the federal government, when the current budget expires on Friday 4th March. Lawmakers must agree on a new spending plan before the deadline, in order to keep the government from running out of money and shutting down. Disagreements between the Democratic and Republican representatives over the funding for several agencies compound the issue. However a proposal by the Republicans, which would see $4 billion cut from the budget, could be agreed upon by the Democrats, given that these would entail cuts proposed by President Obama in his 2012 budget proposal. If agreed upon, then the budget deadline will effectively be extended for another two weeks. However if full budget proposal is not agreed upon then a shutdown will be inevitable.

A shutdown would mean that all non-essential government functions would have to be closed, including officials that are responsible for compiling economic data. Effectively this would mean the release of some US economic indicators could be halted, creating a void in the economic calendar. History shows that the political consequences of a shutdown can be huge, especially if the conflict drags on beyond a few days. The last time the US government experienced a shutdown was during Bill Clinton's Presidency when two shutdowns occurred in 1995 and 1996. Should the US Government enter a period of shutdown, then Dollar price volatility will ensue and this could ultimately lead currency to trade lower against the other major currencies.

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