Foreign Exchange Daily Market Update

Thu, May 12, 2011

The British Pound made a strong advance yesterday following the Bank of England's Quarterly Inflation Report. The report revealed that the BoE had raised its inflation forecasts for the year, with Governor Mervyn King stating that, "there is a good chance that inflation will reach 5% later this year and it is more likely than not to remain above the 2% target throughout 2012". The report forecasted that inflation will return to the central bank's 2% target over the next two years if interest rates are raised to 0.75% in the third quarter of this year. On the other hand, estimates suggest that should interest rates remain where they are, then inflation will stay above target over the same period. In the press conference that followed the report's publication, King said that the BoE was "determined" to rein in inflation back below target levels, indicating that a rate hike this year is likely. The market rallied behind the Pound to push the rate up to 1.6517 against the Dollar and 1.1515 against the Euro. Governor King also stated that the central bank sees downside risks to the nation's economic growth, with GDP growth forecast to be below the historic average over the next year at 2.8%.

Today, March's industrial production figures are expected to show that production has picked up by 0.8%. This follows on from February's 1.2% contraction, while manufacturing production is expected to have risen by 0.3%. However the data may not have much effect on the market considering last week saw the timelier manufacturing PMI slow in April, although a positive outcome could allay fears that the UK's recovery is stalling.

The Euro weakened on Wednesday morning after the final revisions to Germany's Consumer Price Index, remaining unchanged from preliminary readings. With April's price growth at 0.2% month-on-month and 2.4% annually, traders who were hoping for a stronger advance were disappointed. The Euro's suffering was further exasperated by Finland's National Parliament, who remained undecided on committing themselves to taking part in the Portuguese bailout.

May's edition of the ECB's monthly bulletin headlines the European calendar this morning. Traders will be interested in what the report reveals on the ECB's outlook on the current economic climate, and the report will likely alter the euro's price direction depending on the tone it adopts. If the report provides a hawkish sentiment then the Euro is likely to gather strength as rate hike expectations pick up, while dovish sentiment will push the exchange rate lower.

For the Dollar, the currency ended the day trading much higher against the other major currencies. After having initially fallen against the Pound, the Dollar retraced its losses to see GBP/USD fall to a daily low of 1.6322. The move was prompted by a few factors including; a rise in risk aversion and hawkish commentary by Fed member Narayana Kocherlakota. Kocherlakota, who is the Minneapolis Fed President, said he was confident that GDP growth would hit 3-3.5% in 2011. He added that with core inflation rising and healthy growth in the labour market, conditions warranted a 50 basis point hike in interest rates by the end of the year. Meanwhile, figures released by the Commerce Department showed that the US Trade deficit widened by more than was expected in March. The report showed that the trade deficit widened to $48.2 billion in March from a revised $45.4 billion in February. The wider deficit was created as a result of the value of import rising slightly faster than that of US exports.

Advance retail sales could bolster the Dollar as forecasts call for sales to grow by 0.6% in April compared to the 0.4% increase in March. As the US is a highly retail driven economy, improvements in the retail sector are a positive sign for the nation's recovery. Elsewhere on the docket, April's Producer Price Index is expected to advance to 6.5% from the previous rate of 5.8%. The core index, which excludes food and energy costs is expected to rise to 2.1% from 1.9%. With both indexes expected to show price growth, the Federal Reserve will be placed under further pressure to raise interest rates later this year which will likely prompt an appreciation in the Dollar.

In the early hours of this morning the Australian Dollar slumped against the other major currencies following disappointing employment figures for April. The Australian Bureau of Statistics' report showed that employment fell by 22,100 individuals in April to 11,436,500, completely missing expectations for 17,000 jobs to be added. The report showed that full-time employment fell by 49,000 jobs but this was partially offset by an increase of 29,600 part-time jobs. The unemployment rate remained stable at 4.9%. The outcome led the GBP/AUD exchange rate to rise to an early high of 1.4556, while against the US Dollar the exchange rate slumped to 1.0585, making this a good time for those individuals that are holding Aussie Dollars to exchange them for Sterling.

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