Foreign Exchange Market Overview

Wed, March 23, 2011

Consumer Prices in the UK grew beyond market expectations, when the annualised inflation rate came in at 4.4% in a year to February. The outcome marked the highest reading since October 2008. Retail prices also out performed forecasts as prices advanced 5.5% year-on-year. The outcome provides support for hawkish monetary policy makers, who have been seeking for an interest rate hike to combat inflation, which could take place as early as May. As a result the Pound strengthened against the US Dollar to post a high of 1.64, while against the Euro the exchange rate retraced recent declines back to a high of 1.1543. With inflation on the rise the Bank of England's minutes to the their March meeting is expected to show a growing shift in the Monetary Policy Committee, with member showing an increased willingness to raise interest rates. Should the minutes actually reveal a hawkish shift in sentiment then we could see the Pound continue on its recent upward trend.

Not all was good news for the UK however, as public sector borrowing totalled 10.28 billion in February according to reports released by the Treasury department; this is a sharp turn around from January, when total borrowing fell by 6.3 billion. Given that February's government borrowing was much higher than anticipated, the government may look into alternate methods for reducing the country's deficit, which would be revealed when the Chancellor of the Exchequer George Osbourne, announces his budget statement at 12:30 GMT. The government already has ambitious austerity measures planned which economists expect to weigh on the UK's outlook for growth, so should the Chancellor see fit for tougher measures to be implicated, then the Pound could suffer as the outlook for growth weakens further. This in turn could sideline the possibility of a rate hike in May, for one much later in the year. However the Chancellor has already mentioned that he intends to stick with his existing plan.

Rate hike expectations continued to push the Euro higher against the US Dollar, with the currency pair reaching a monthly high of 1.4247. Jurgen Stark of the ECB said with inflation rates expected to remain above 2% through out next year, the central bank can see scope to begin normalising monetary policy as the economic recovery continues. On Monday both Executive board member Gertrude Tumpel-Gugerall and Governing Council Member Yves Mersch both said "strong vigilance" was required when keeping inflation in check a phrase often used when the ECB is preparing for a rate hike. It's worth noting that there is still a chance that the ECB will decide not to raise the interest rate in April, as there are many of the peripheral European countries that are still suffering from a weak economic recovery and a rate hike may hurt these economies.

Today's European figures are set to show that the Euro-zone's industrial orders for January grew by 21.4% annually up from December's 19.3%, while month-on-month new orders are expected to slow to only 1.0% increase. Later in to the day, a consumer confidence survey for the entire Euro-region is expected to show that consumer sentiment in March fell. The thin economic data will most likely be overlooked by economist, as they instead turn their direction towards the Portuguese budget vote due to take place at 03:00 PM GMT. The Portuguese Parliament will be discussing the nation's growth and stability before voting on adopting a more austere budget. Prime Minister Socrates has voiced his concerns that the country cannot survive with lending rates sitting above 7%, and that should the government fail to improve the nation's financial position it could lead to a crisis that can only be resolved with a bailout. Ultimately a bailout would weigh heavily on the Euro.

The US dollar extended its losses against both the Pound and the Euro yesterday as the economic docket reinforced a negative outlook for the world's top economy. House prices fell in January by 0.3%, beating expectations for 0.2% decline, while the Richmond Fed Manufacturing Index reported that manufacturing activity slowed in March. On the upside Cleveland Fed President Sandra Pianalto said she expects the U.S. recovery to continue at a moderate pace, stating "The recovery seems to have established a firmer footing. I am seeing clearer signs of a virtuous cycle of growth."

New Home sales are expected to have risen in February by 2.1% after January reported a fall in home sales of 12.6%. Given that reports from earlier in the month have shown that the sale of existing homes have fallen during same period, the possibility of an outcome to the downside is very real. If today's reports show further evidence of a weakened US housing market, then the Dollar could trade lower against the majors.

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