Sterling gains against euro and dollar; markets eye Thursday's MPC meeting

Tom Tong08/Feb/2011Currency Updates

GBP

Sterling received support yesterday ahead of Thursday’s MPC meeting with speculation of rate hikes still rumbling in the background. As such, the pound made ground against the euro and dollar. Despite the financial markets expecting an interest rate hike in May, with many seeing short term hikes as priced in, sterling is benefiting from expectations of an early rate hike. After the poor Q4 GDP figures, now largely viewed as overcautious by the ONR and heavily due to the bad weather, sterling has rebounded on the back of the positive PMI figures last week reinforcing the case for UK monetary tightening. However, many analysts feel the wave of optimism due to higher inflation and expected hikes was naive and misguided. They feel that premature rate hikes could cause longer term problems for the pound as individual incomes are put under more pressure which could undermine the longer term recovery. This morning’s retail sales figures came out higher than anticipated and gave the pound a micro boost, but moves were limited due to poor January RICS housing data overnight.

USD

The dollar remained subdued against sterling yesterday but clawed back some ground against the euro after poor German figures. The dollar benefitted from Friday’s jobless report, which highlighted a reduction in the unemployment rate to 9% last month. This news led to a rise in benchmark US yields and a widening of the spread against 10-year German bunds in favour of US treasuries, a move that added to the appeal of the dollar. The dollar has been underperforming due to expectations of rate hikes in the euro and the UK prior to those by the Fed in the US. However, the expectations driving the market could prove too speculative with the ECB head Trichet subduing his Hawkish tone this week and the MPC meeting yet to come. This changing rhetoric in the ECB caused yesterday’s pullback against the euro. Various recent positive economic reports have helped improve the US economy’s outlook and suggest that the Federal Reserve may not need to stimulate the economy any further, but the Fed still remain cautious, as echoed by Bernanke last week.

EUR

The euro lost ground against sterling and the dollar yesterday as Trichet doused speculation of rate hikes and weak German industrial orders data triggered euro selling. Jean Claude Trichet, head of the ECB said that inflation would remain naturally contained without further tightening measures. German industrial order data also disappointed and, combined with Trichet’s comments, sparked speculators into a bout of profit taking on the euro’s New Year rally, causing GBP/EUR to test 1.19 and EUR/USD to fall to 1.35. This morning the euro has edged of a two week low supported by more Asian market players returning from Lunar New Year holidays and Chinese New year. The trend of Asian banks supporting the single currency through euro purchases limited yesterday’s move.

Currency Wars

Previously we have spoken about the currency wars and The United States seem to have found an ally in Brazil in there war to combat China and the undervalued yuan. Yesterday Brazil vowed to pressure countries that keep their currencies undervalued, forming an unofficial alliance with US policy. The weak yuan is as troublesome for Brazil as it is the US as a weak yuan is a threat to Brazil’s economic boom. A flood of cheap Chinese imports, combined with a surge in the value of the Brazilian currency, has eroded Brazil’s trade surplus while causing the loss of thousands of manufacturing jobs.

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Written by Tom Tong

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