Foreign Exchange Market Overview

Wed, April 27, 2011

The Pound was unable to hold its ground against both the Euro and the US Dollar yesterday, as the limited data on offer provided a weakened outlook for the UK economy. The currency slipped from its high of 1.6532 against the Dollar, while GBP/EUR continued on a path of steady decline from the early hours of the morning to trade below 1.1250. According to reports from the Confederation of British Industries, factory orders in April fell by a greater than expected margin, with the total orders index slipping from March's reading of 5 down to -11, when expectations had called for a reading of 2. However the CBI's business optimism index showed that sentiment improved with the index rising from last month's figure of 7 to 9, just missing the consensus for the index to read at 10.

Today's focus has fallen on the nation's first quarter GDP figures which cam in line with analysts' expectations for a 0.5% growth rate in the economy over the first three months of the year, reversing the 0.5% contraction seen in the last three months of 2010. The market so far has reacted positively to the outcome with the Pound rising from this morning's low of 1.6433 against the Dollar to test a fresh high of 1.6537, while against the Euro the Pound is set to reverse some of yesterday's declines as the exchange rate is pushing forward from 1.1262 and could make a run for 1.13.

The Euro gathered strength over the course of yesterday, rising from an early morning low of 1.4493 to peak at 1.4652 against the Dollar. This was partly owed to the morning's report on the Euro-zone budget deficit in 2010 revealed that the region's budget gap was 6% of GDP down from 6.3% in the previous year. However public debt was up 85.1% from 79.3% in 2009. Ken Wattret, chief euro zone economist at BNP Paribas commented on the findings saying, "Collectively, the state of the public finances in the euro zone is not as bad as in the UK, the US or Japan. The problem, of course, is the huge divergence at national level." Given that sovereign debt is an on going issue within the Euro-zone, much of the Euro's advance against the Dollar is probably due to a fundamental weakness in the US currency.

Germany's preliminary Consumer Price Index for April could raise expectations for the ECB to make its second interest rate hike of the year at May's policy meeting. This is because traders forecast inflation to hit an annualized rate of 2.4% up from 2.1%. Previously the Euro has benefitted from rising interest rate expectations, despite ongoing sovereign debt problems, so the foreign exchange market could well see the currency continue on its upward trend today. Further to this the forward looking GfK consumer confidence survey for Germany is expected see sentiment in May show a negligible decline with the index falling from 5.9 to 5.8, while new industrial orders for February are expected to have risen by 1.5% following 1.2% increase in January.

Economic figures out from the US yesterday were mixed as the Conference Board's consumer confidence index improved in April. Sentiment amongst consumers increased as conditions improved in the US jobs market, with the index rising to 65.4, beating forecasts for a reading of 64.5. The gauge on future expectations suggest that sentiment in later months could also be on the rise, as forward looking expectations rose from 81.3 to 82.6. However counter to this, the Richmond Fed's manufacturing index unexpectedly dropped in April to 10 down from 20, while the consensus had been for activity in the district to remain unchanged. As manufacturing has lead the US recovery, the slow down in manufacturing activity as indicated by the data could trouble some US policy makers since it could a precursor to further economic weakness and therefore a need for continued stimulus.

The subject of fiscal stimulus will feature prominently at the Fed's monetary policy meeting which is scheduled to conclude this afternoon. The Federal Open Market Committee's (FOMC) meeting will be closely watched for insight into Fed policy makers' outlook on inflation and economic growth. In particular traders will want to know if Fed Chairman Ben Bernanke is looking to unwind the current Quantitative Easing (QE) measures. Such decision could be potentially seen as a sign that US economy is strong enough to support itself without stimulus and as a result could reverse some of the declines the Dollar saw yesterday. However any mention of renewing the QE program for a third run would have a bearish impact on the Dollar. Aside from the FOMC's policy meeting the docket is expected to see the number of durable goods ordered in March rise by 2.1% following February's 0.6% contraction. Considering the value of most durable goods, an increase in these orders suggests that consumers are growing more confident in their financial situation to make such expensive purchases, which in turn is supportive of the Dollar.

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