Carney's first Inflation Report buoys Sterling against Euro, dollar

Tom Tong12/Aug/2013Currency Updates

Sterling was the outstanding performer among major currencies last week. The all-important August inflation report revealed that the threshold adopted by the Bank of England before considering monetary tightening was somewhat less stringent than expected. The resulting realignment of policy expectations boosted Sterling, which ended up higher against all major currencies but the Japanese Yen. Away from currencies, commodities rose, led by metals, on stronger data from China that eased fears of a slowdown, and equities generally pull back slightly from their recent highs.

GBP

The release of the all-important August Inflation Report by the Bank of England brought the fireworks that were expected. Carney clarified the “thresholds” in unemployment that must be reached before the Bank considers tightening monetary policy. This was set at 7%, while market expectations had pegged it closer to 6.5%. Furthermore, “knockouts” were introduced that would cancel the threshold if the Bank’s projection for inflation two years from the present exceeded 2.5%. Overall, then, the message was significantly more dovish than the market expected, and Sterling rose sharply immediately following the publication of the report. Macroeconomic releases also buoyed the currency, as the services PMI hit a six-year high at a very expansionary 60.2. GBP ended the week higher by 1% against the Euro and slightly better against the US dollar.

EUR

The string of better-than-expected macroeconomic data out of Europe continued last week. The recession in Spain and Italy ease somewhat in the second quarter, as their respective economies shrank by 0.4% and 1% q/q saar (seasonally adjusted annual rate). German industrial production rose by a strong 11.6%, driven partly by a bounce back in construction. The recent data is consistent with a very modest overall second quarter growth in the Eurozone in the 0.5-1% range. This growth comes after six consecutive quarters of contraction. Furthermore, it is far too sluggish to make a dent in the unemployment figures. Therefore, we think commentators are getting a little too carried away with the European recovery story and think the recent rally in the Euro is an excellent opportunity to hedge exposure to the common currency.

USD

Another week of much stronger than expected economic data has quieted fears of a slowdown in the US, and has significantly increased the chances of a September start to the “tapering” of QE3. This, by the way, has been and remains our call for the next move in the Federal Reserve policy. The PMI index of service business confidence surged to 56 – well above trend expansion. We reiterate that this index has been in the past the best real-time predictor of GDP growth in the US. Further good news came from the June trade deficit (down sharply) and the latest weekly jobless claims (down to another cycle low). Conditions are in place for an acceleration of US growth to modestly above-trend levels, which should help widen the gap between expectations for US future rates and those of its main trading partners, and therefore support the dollar.

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Written by Tom Tong

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