Republican U-turn on tax creates uncertainties over the arranged budget and brings back volatility in the Markets

Tom Tong19/Dec/2012Currency Updates

GBP

The British Pound continued to temper the decline from September. Consumer prices in the U.K. increased another 2.7% in November to mark the fastest pace of growth since May, and steady price growth may prompt the Monetary Policy Committee to shift gears in 2013 as the central bank expects inflation to hold above the 2% target over the next two-years. This may lead to the BoE talking down speculation for additional monetary support, and the central bank may sound more hawkish this time around as the U.K. emerges from the double-dip recession.

EUR

The Euro climbed to a fresh 7.5 month peak against the dollar on Tuesday, boosted by optimism about the chances for a U.S. budget deal, with many believing that the Euro is entering a deflationary cycle. It is hard to argue with his logic. Japan has seen the Yen strengthen dramatically during its two-decade bout with deflation. The dollar rallied strongly in the wake of the mortgage meltdown in the US and the subsequent reduction of debt that went with it.

Global Investors are preferring Euro Zone Shares to US ones for the first time in two years as concerns of a major risk event in the single currency bloc ease, a fund managers’ survey showed on Tuesday. 22 percent cited the crisis as the biggest risk factor to their assets, down from 65 percent in June. “The positioning of overweight European equities has tracked very closely with the decline in risk, or perception of risk, for Europe” said John Bilton European Investment Strategist for the BOAML.

It was also announced that Latvia will apply to join the Euro zone in February, its finance minister told Reuters, confident that it will be accepted and can overcome domestic opposition. Latvia is one of the fastest growing economies in the European Union recovering from years of austerity following a 20 percent output drop in 2009 after the global financial crisis hit. Vilks the minister expects Latvia to have a budget deficit close to 1.5 percent of output this year, well below the 3 percent EU target.

USD

Backtracking from John Boehner, the Republican Speaker of the House of Representatives, announcement yesterday that he was preparing a back-up plan to extend current tax rates for all Americans except millionaires, in case talks to avert the fiscal cliff failed. This can be seen as a U-turn or at the very least an attempt to appease those who criticized initial leaks emerging from deal meetings. The Financial Times reported only two days ago that John Boehner had agreed raising income tax rates for Americans earning more than $1m a year, a big concession in negotiations with President Barrack Obama and was seen as very much a breakthrough.

With only two weeks until the onset of $600 billion in automatic tax rises and spending cuts that could trigger a new recession, the White House remains locked in talks with Congress to reach a deal before time runs out. In a move widely seen as act of brinkmanship, John Boehner, laid out a plan to prevent tax rises.

The only thing that can give the dollar a fighting chance at self-generated strength is a serious move towards risk aversion. But given that most of the major uncertainties for the immediate future are behind us (GDP figures, Euro-area crises decisions, Fed stimulus refreshers), the USA status of a safe heaven is safe for now, at least in the short-run.

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Written by Tom Tong

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