Stocks rally as European officials take action

Tom Tong22/Jul/2011Currency Updates

GBP

There was a significant amount of event risk for the UK on the calendar yesterday (consumer confidence, public borrowing and retail sales); sterling brushed the data aside.

The pound rose on the euro’s coattails, although retail sales rose 0.7% on the month, more than forecast and reversing a fall of the previous month. Few in the market believed it would change the outlook for UK interest rates, which are expected to stay low until well into 2012 as the economy struggles to recover.

A weak economy has battered economic sentiment – consumer confidence fell in June, reversing some of May’s jump and dousing hopes that Britain’s economic recovery will gain traction.  Data has been on the softer side. Consumer Confidence isn’t high and people are not spending.

Minutes from the Bank of England’s latest policy meeting released on Wednesday added to the view that the economy continues to suffer, as they showed that policymakers believe Britain’s growth outlook has darkened. The possibility of expanding the BoE’s asset-buying programme to stimulate the economy also remains, with policymaker Adam Posen on Thursday saying he hoped the central bank would decide to expand its quantitative easing program.

EUR

Yesterday’s eagerly anticipated European Union summit on the spreading sovereign bond and broader credit crisis yielded a more conclusive program to stabilize the region than most had expected.

Immediate support was provided through a 109 billion euro bailout programme for Greece, along with an additional 37 billion euros in voluntary participation from the private sector (with another 13.5 billion euros in potential buybacks).  Attempting to halt further contagion, officials agreed to reduce loan rates for Greece to 3.5% from 7.5% and extend their terms to a range between 15 and 30 years. More importantly, these favourable terms would be extended to Ireland and Portugal which are the next theoretical domino.

It was further decided that the EFSF could pre-emptively lend to governments, who would redistribute capital to their troubled banking systems and even intervene in the secondary market when the ECB determines the markets are experiencing exceptional circumstances.

USD

Although there was US dollar related news on Thursday (Unemployment, Philly Fed and the Ben Bernanke speech) its influence was muted. The greenback’s link to the euro is certainly strong enough that the extraordinary efforts in the EU would have remarkable repercussions for the benchmark currency. Momentum behind the euro peaked around the US open. Perhaps the dollar’s primary appeal in the currency market is its unsurpassed liquidity – a safe haven when financial conditions start to break down. Yet, with that role already suffering from on-going debt ceiling debates, a sudden drop in demand for safety with a European ‘fix’ sees demand for the dollar recede. There will be heavy debate over the effectiveness of the EU plan going forward, but the dollar could still gain traction under the right circumstances. Underlying sentiment trends are still over-extended and thereby prone to triggering flights to safety. Additionally, the USA is still awaiting a debt ceiling solution.

CAD

Today sees the release of the June CPI and May retail sales figures. This is a perfect combination to colour interest rate expectations which are currently bolstering a 26% probability of a 25 bps hike at the next meeting and 55 bps over 12 months.

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Written by Tom Tong

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