U.S. consumer price index (CPI) rose by a smaller than expected 0.2%, while core CPI also by a weaker than expected 0.1% increase, translating into an annual rise of 3.9% and 2.9% in headline and core CPI. Regardless of whether these softer than expected figures reflect the true story of inflation in the U.S. economy, they bear positive implications for risk appetite, U.S. equities and prolonged yen weakness and CAD strength. But the figures may temper the dollar’s recent gains as they do not necessarily shut the door on a June rate cut.
More sterling damage
The British pound dropped nearly another full cent to a four-month low of $1.9366 after the much anticipated quarterly inflation report from the Bank of England projected inflation to surge to as high as 3.7% annually in the third quarter of this year, before slipping to around 2.25% in two years. The BoE clearly expects further downside in growth, anticipating GDP growth slowing to near 1.0% by end of 2008, with chances of a contraction before attaining 2.4% in 2 years. The central bank has left very little doubt that it has joined the Federal Reserve in facing stagflation-like challenges. But the Bank of England stands out from the rest of major central banks in that it is expected to deliver the biggest policy easing going forward, mainly due to the relatively high level of its short-term interest rates currently at 5.00%.
GBP/USD to retest the $1.9360 low, below which it is seen extending losses towards $1.9335. We expect the key 1.9300 foundation to be broken within the next month once the pair caught up between further BoE cuts in June and speculation of a hold in rates from the Fed. Resistance has dropped to 1.9460 while the 200-week moving average is expected to act as the next key resistance at 1.9490.
EUR/GBP faces further upside despite a struggling EUR vs. USD as the pair exploits prolonged UK weakness. Cross pair is expected to target key resistance at 0.7965-70, which is the 61/8% retracement of the decline from the 0.8096 high to the 0.7762 low. Baring any explicit signs of Euro zone weakness, we see EUR/GBP following on 0.7990, with medium-term outlook suggesting 0.8035 near quarter’s end.
Euro remains consolidated
The bulk of the euro’s losses emerge from USD strength against GBP and AUD spilling over onto the EUR amid relative silence on the ECB hawkishness front. Euro zone industrial production fell by less than expected, showing a 2.0% annual decline versus forecasts of 2.4%. We continue to note robust support at $1.54, backed by 1.5370 until the release of the month’s IFO, ZEW and PMI surveys shed the latest signal on the extent of the Euro zone slowdown and whether ECB rate cuts are warranted. We do not buy into speculation that the ECB is preparing for a shift towards dovishness. The central bank’s inflation concerns shall remain more than lip service and will only recede in the event of starker evidence of a Euro zone slowdown. It is important to note that the ECB’s inflation mandate does not require it to be ahead of the growth curve when inflation is being compromised.
We expect euro to retain weak bias, facing resistance at 1.5495-00, followed by trendline resistance at 1.5530. Interim foundation stands at 1.5370, followed by 1.5350.
USD/JPY supported by shifting attention
Yen crosses (including USD/JPY) have soared across the board as the focus has shifted fears of systemic risk to concentrated market themes; weak sterling, broad USD advance and struggling metals. Taking their queues from the yield curve, currency traders identify receding chances of further Fed easing as the 10-2 yield spread drops from its 200-bps high to 140-bps, the lowest level in nearly four months. Rising U.S. inflation is expected to further lift USD towards the 105.50, followed by 105.70 at which point we’re likely to see the bulls recede and nervousness over the economic implications for accelerating US inflation. Support climbs to 104.75.
Loonie flies high
The Canadian dollar has soared across the board despite no marked increase in oil prices. CAD strength and JPY weakness are manifestations of falling risk appetite. The weaker than expected U.S. inflation figures are expected to trigger further CAD gains, dragging USD/CAD towards 0.9940, backed by 0.9910. Upside capped at 0.9990.
Ashraf Laidi
Chief FX Strategist
CMC Markets US
a.laidi@cmcmarkets.com
