Euro retreats as Trichet dampens rate hike expectations; UK service sector expands

Tom Tong04/Feb/2011Currency Updates

GBP

Sterling pared gains versus the dollar on Thursday in a move driven largely by a sharp drop in the euro after European Central Bank President Jean-Claude Trichet dampened expectations for a rate hike in the Eurozone.

Trichet’s comments, which came after the ECB’s decision to keep interest rates at a record low 1 percent as expected, disappointed investors who had expected a more hawkish statement after recent inflation data came in above forecast.

The pound had risen to a three-month high versus the dollar in morning trade after UK services PMI data came in above expectations, bolstering the case for higher interest rates in the UK.

Against the euro, sterling soared to two week highs as the UK markets awoke this morning.

Activity in Britain’s dominant services sector expanded at its fastest pace in eight months in January as business recovered after December’s snow disruption.

Thursday’s purchasing managers’ survey from Markit/CIPS also showed a record jump in input cost inflation in the services sector, which is likely to worry Bank of England policymakers who hold their rate-setting meeting next week.

“We would hesitate at this stage to say that the recovery is back on track. With so much uncertainty about the underlying pace of growth, we still doubt that the MPC will want to risk tightening policy prematurely.” said Vicky Redwood, Senior UK Economist at Capital Economics.

Implied interest rate futures based on overnight index swaps were almost fully priced for a 25 basis point rate rise in May, up from around 40 percent last week after a shock 0.5 percent contraction in UK fourth quarter gross domestic product.

“We see further modest upside potential toward the mid $1.60s – based on the BoE following through with a rate hike, possibly as early as May,” said Lee Hardman, currency strategist at BTM-UFJ.

EUR

The euro was on the defensive on Friday after European Central Bank President Jean-Claude Trichet poured cold water on expectations for a near-term rate hike, wrong footing bulls who had expected more tough talk on inflation.

Whether the euro’s retreat from a 12-week high will continue now hinges on US job data due later in the day, with a break of support around $1.3535-70 seen as a potential sign of more losses down the road.

Trichet, speaking after the ECB’s decision to keep rates at a record low 1 percent on Thursday, said inflation expectations remain “firmly anchored” and inflationary pressures over the medium to long term “should remain contained”.

His comments disappointed investors who expected a more hawkish statement after recent inflation data came in above forecasts. Expectations the ECB would lift interest rates sooner than the Federal Reserve had boosted the euro in recent weeks.

Against the dollar the euro traded down 1.2 percent on the previous day, moving further away from a 12-week peak set on Wednesday, and slumping to two week lows against sterling erasing temporary gains made after the Eurozone managed to ease sovereign liquidity issues at the end of January.

USD

The US trading session was filled with strong economic reports that saw US unemployment claims fall to 415K from 457K for the previous week. Economists had expected 420K new jobless claims. ISM Non-Manufacturing PMI was significantly stronger, up to 59.4 after an expected 57.4 mark. Any reading above the 50.0 level represents growth in the economy. US factory orders also unexpectedly rose by 0.2% on expectations of a 0.2% decline.

Strong economic data combined with the ECB interest rate decision had the USD mixed versus the majors. Versus the euro the dollar saw its strongest gains of the new year. The EUR/USD closed the day down just over a percent..

The market’s attention will now shift to the all-important US Non-Farm Payrolls report which is due out today at 13:30. Economists forecast the US economy added 138K new jobs in the month of January but the unemployment rate is expected to rise to 9.5% from 9.4%. Strong employment data from the US may have significant ramifications on the dollar and the Fed’s outlook on the economy. Should better than expected non-farm data show an improving employment scenario, the Fed may begin to pull back on their loose monetary policy which would be a positive for the dollar.

ELSEWHERE

Japanese shares rose on Friday, lifted by news of a mega merger in the steel sector, while a rebounding dollar put a slight dent in a commodities rally that saw copper hit a record $10,000 a tonne in the previous session.
Tough competition from steelmakers in China and India, shrinking demand from domestic automakers and rising prices for raw materials such as coal and iron ore prompted the deal which would likely see Nippon Steel acquiring Sumitomo Metal, valued at $11 billion.

Shares of Nippon Steel and Sumitomo Metal rallied sharply, rising 9 percent and 16 percent, respectively.

“The news will likely raise expectations that more Japanese companies will seriously try to increase their competitive edge in the global market,” said Shinichiro Matsushita, a senior market analyst at Daiwa Securities.

While there are signs that the global economy is gaining momentum, many market players remain on the sidelines, eyeing developments in Egypt after the White House was said to be discussing the immediate resignation of Hosni Mubarak as one of several scenarios for a transition of power.

The US move comes after 10 days of anti-government protests in Egypt and ahead of a mass “Day of Departure” rally planned by protesters in Cairo’s Tahrir Square on Friday to force Mubarak to quit.
Clashes between pro- and anti-Mubarak demonstrators have fuelled fears of possible disruptions to energy supplies and boosted crude oil prices, which were headed for a second straight week of gains.

Brent crude for March gained 31 cents on Friday to $102.07 a barrel at 0525 GMT, after touching $103.37 on Thursday, the highest intraday price since Sept. 26 2008, and then sliding on a stronger dollar. US crude rose 39 cents to $90.93.

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Written by Tom Tong

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