Euro rallies after Trichet leaves door open for further hikes

Tom Tong08/Jul/2011Currency Updates

GBP

Thursday saw July’s Bank of England rate decision; the bigger fundamental impact would come through a report from the ONS showing the biggest jump in manufacturing output in 14 months. Unlike its Eurozone counterpart, the BoE does not offer explanation or expectations when policy is held unchanged – rendering the event impotent. That said, the draw of a higher European yield does work to direct capital away from the UK.

The committee’s decision comes despite the annual rate of inflation remaining at 4.5% in May, well above the Bank’s 2% target. The bank also kept its programme of quantitative easing unchanged at £200bn.

The MPC is split over which is the greater problem, the weak economy, which recent data suggests has slowed from the 0.5% growth of the first quarter, or inflation, which is squeezing consumers’ purchasing power.

The National Institute for Economic and Social Research’s latest forecast suggests the UK economy barely grew in the second quarter of year. It predicts growth of 0.1%, below other recent estimates which predict a rise of 0.3%.

The first official estimate for second quarter gross domestic product (GDP) will come on 26 July.

This morning sees the release of UK Producer Price Indices for June which are expected to show a slight growth in output YoY.

EUR

There was no surprise in the ECB’s announcement that it would be raising the ECB’s lending rate 25 basis points (bps) to 1.50%. The real debate rested with what central bank President Trichet would let slip at his press conference. The market is adept at processing the nuance of this policy officials’ rhetoric as a guide for conviction and timing for future policy changes. Without the phrase ‘strong vigilance’, the market deems it unlikely that there will be another hike in August, but September is still on the table given their reflection of accommodation. An expected (but still jarring) step, Trichet also announced that despite the recent Moody’s downgrade the ECB would support Portugal by continuing to accept the country’s debt as collateral in return for funding. He said that ‘We have decided to suspend the application of the minimum credit rating threshold… This suspension will be maintained until further notice’.

Asked if the rate rise would do more damage the Eurozone’s periphery economies, Mr Trichet said that ‘the entire continent would benefit from maintaining price stability and confidence’. He continued by saying that confidence was the ‘solid soil’ on which the Eurozone would build, despite some countries expanding at a faster pace than others.

The continuing strength of Germany’s economy was underlined this week with figures showing that manufacturing orders rose 1.8% in June. Many analysts had forecast a fall. Additionally, early this morning Germany has posted a stronger than expected Trade Balance for May and a weakened Current Account figure broadly as expected.

USD

Today there is notable event risk ahead for the US dollar with the release of non-farm payrolls; the currency has experienced volatility over the past 24 hours. The impact of the ECB rate decision spilled over to the greenback; while a surprise jump in the ADP private payrolls fuelled risk appetite trends.

Thursday saw continued deadlock as President Barack Obama told top US lawmakers on Thursday that he would not sign a short-term extension of the US debt ceiling and said negotiators would work through the weekend on a deal to avoid a debt default.

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Written by Tom Tong

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