Sterling bolstered as strong services data points to UK growth

Tom Tong06/Apr/2011Currency Updates

GBP

The pound surged against the euro and US dollar on Tuesday after a report showed that service industries in the UK expanded at a faster pace in March, boosting expectations of a near-term rate hike.

The UK PMI index showed that the service sector is growing at its fastest pace in over a year and pointed to solid first-quarter GDP growth, making a Bank of England rate rise in May increasingly likely. Services constitute a large percentage of the economy and such a positive reading bodes well for the first quarter GDP figures released at the end of the month.

The UK has now witnessed positive construction and manufacturing figures over the last couple of days, which is adding weight to the cause for Bank of England to tighten policy.

Today’s focus will turn to the industrial production and manufacturing figures which are released at 09:30. A positive reading would prove to be bullish for the pound and could see the currency make further gains.

USD

The dollar found a lack of support for the early shift in rate speculation from the FOMC as the market absorbed comments made by Fed Chairman Ben Bernanke on Monday. If the hawkish calls grow, we could see a rise in expectations of a Q4 US rate hike grow and dollar gains in advance of the actual decision.

A dramatic sterling rally (following a better than expected in UK Services PMI) triggered the biggest rally from the ‘cable (GBPUSD) since January 12th.

The most liquid currency pair, EURUSD, (and the foundation of the Dollar Index) made no significant progress for the seventh consecutive day. The average true range on this pair (an indicator of trend and activity) dropped to its lowest level since September with Tuesday’s close.

EUR

The euro fell a percent against a broadly firmer sterling on Tuesday, with the pound was buoyed by renewed expectations of a near term rate hike after strong services data.

Credit rating agency Moody’s cut Portugal’s sovereign debt by one notch, saying it believed an incoming government would need to seek financing support from the European Union as a matter of urgency. The cut in Portugal’s long-term rating to Baa1 from A3 still leaves Moody’s evaluation of its debt two notches higher than fellow agency Standard and Poor’s, but a notch below that of Fitch Ratings.

Moody’s said the debt was still under negative review, with further downgrades dependent on Lisbon’s ability to secure medium-term funding. While Portugal can probably go on funding itself for the next eight weeks, it has to refinance 4.3 billion euros ($6.1 billion) of debt in April and 4.9 billion in June – the cost of which is likely to go on being punitively high.

The market’s attention is likely to focus on the European Central Bank meeting on Thursday. Markets expect the ECB to raise rates by 25 basis points as it becomes the first G-3 central bank to start normalising monetary policy after the global financial crisis.

“But a lot has been priced in for the euro already, certainly in terms of the rate hike that’s due on Thursday,” said Kathleen Brooks, research director at FOREX.com, adding that “there’s the potential for euro/sterling to cross further after today’s big move.” Further sentiment this week came from Citi in a note on Tuesday highlighting that the market was getting excessively hawkish on the European Central Bank relative to the BoE, stating that “risks related to the growth outlook for peripheral economies were growing compared to those in the UK and that will also help sterling outperform the euro.”

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Written by Tom Tong

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