British pound jumps on inflation concerns

With a ton of data due to be released throughout this week investors can expect to be on edge. Wednesday brings a slew of economic reports from China including second quarter growth with onlookers desperate to learn just how effective the authorities’ efforts to temper property speculation and rein in lending have been. The impact on growth-sensitive currencies could be huge in either direction as a result. U.S. second quarter earnings are projected to rally by 34% on the same period last year with corporate profits likely to impact the value of the Japanese yen.

On Tuesday the British pound jumped after a release indicated no let-up in the pace of price increases for the nation. Difficult to measure, however, is whether the British economy is undergoing strengthening demand, which is lifting prices, or whether it’s a simple case of stubbornly rising prices finding their way through the system. The pound gained against 14 of 16 trading partners.

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British pound – The pound jumped to $1.5117 reversing all of Monday’s losses against the dollar having reached $1.4965 ahead of Tuesday’s data. A minor monthly gain rather than a flat reading for the consumer price index in June caused a slower annual decline than forecast to 3.2% after it rose by 3.4% in the year through May. However, the pace of increase in the core annual reading of CPI picked up to 3.1% from 2.9% after it was predicted to slip to a 2.8% pace.

Recently one of the external members on the central bank’s Monetary Policy Committee broke ranks with members by requesting an interest rate increase. Some of today’s rally in the pound is likely due to increasing expectations for the need to lift rates given the stubborn performance of inflation. The official line at the Bank of England remains that temporary rises in food and energy prices will likely dissipate and that it would be a mistake to raise interest rates when the projected path for inflation at the end of a two-year forecast period is likely to decline beneath target. The pound also gained on the euro which today buys 83.25 pence and currently buys exactly $1.5100.

In other economic news the British Retail Consortium reported the strongest sales gain in three months in its June data, which came in at 1.2%. Meanwhile there was less comforting news for homeowners as the pace of price expansion, albeit positive, narrowed from +21 to +9 according to a RICS survey. The index compares the net number of positive responses versus negative responses. The surveyors report also showed lower new buyer interest at a time when the number of homes put up for sale expanded, bringing into question the sustainability of the recovery in home prices.

Euro – The process of stress-testing European banks’ balance sheets in order to explain their vulnerability to government default or debt restructuring continues as EU finance ministers meet in Brussels. The preparation is all-important for investors to comprehend and assess the outcome. According to German Finance Minister Wolfgang Schaeuble the aim is to create stability while any consequences arising from the revelations need to be resolved. Such resolution should lead to a sense of clarity over the health of European banks.

For now that means that investors want to know what to expect and how deep and meaningful the testing process really is. According to Robert Mundell of Columbia University there is a one-in-five chance that governments of Spain, Portugal and Ireland might restructure their debts, while the chance of Italy needing to do so is one-in-10. The likelihood that Greece must do so is 40%. Under such a restructuring process investors want to know the extent of stress to balance sheets given individual exposure to sovereign debt.

The euro is feeling minor stresses of its own in the period leading up to the release scheduled to be July 23. Having stretched to $1.2722 on Friday the euro continues to trade softly at $1.2584. Data today from the ZEW Institute showed that the July reading for economic sentiment in the euro-area slumped between months from 18.8 to 10.7 and well below a predicted slim decline.

For Germany, however, there were signs of encouragement within its readings. The index is an indicator looking forward by six months and although the July reading fell to a 15-month low at 21.2 after 28.7 in June, the ZEW current conditions index for Germany broke out of negative territory where it had been for two years. The index jumped from -7.9 to +14.6 after second quarter exports jumped and employment rose. It is indeed possible that while investors respond negatively about the outlook based upon declining financial conditions and market worries over global growth, the reality has been far more prosperous. We could be staring at the nadir for the leading index based upon fears over global recovery as the economy softened at the edges.

U.S. Dollar – Nevertheless the dollar gained marginally against the euro where it’s trading at $1.2577. Moody’s Investor Services helped sour the tone marginally by a credit rating downgrade for Portugal citing its tough fiscal stance and restricted chances for growth. The dollar index is marginally weaker this morning at 84.15.

Japanese yen – The Japanese yen should respond negatively to favorable U.S. corporate earnings. The first test was after Monday’s bell as Alcoa surpassed expectations and raised its forecast for global aluminum demand. Better recovery prospects should undermine the health of the Japanese unit, typically bought for safe haven purposes. However, the yen has strengthened against the dollar this morning to ¥88.27 completely reversing Monday’s weakening. Investors appear to be happier taking a conservative approach ahead of Wednesday’s GDP report from China.

Canadian dollar –We’re a week away from a potential rise in the official Canadian benchmark rate of interest, which many investors seem to think is a slam dunk following the healthiest quarterly labor market performance since records began in 1976. The Canadian dollar is edging back towards overhead resistance at 97.00 U.S. cents and while the midweek slew of economic reports out of China will influence demand for the commodity dollars sooner, one would expect investors to anticipate further the Bank of Canada’s policy intentions as the meeting draws near. The Canadian unit currently buys 96.83 U.S. cents.

Aussie dollar – The Aussie is also approaching key overhead resistance this morning and has staged an impressive rally off an earlier low at 86.83 U.S. cents to trade up to 87.70 cents. An earlier reading of business confidence for June slipped to its lowest reading in a year setting a bearish tone. The mood seems to have picked up after Pacific hours as portrayed by a rebound for global equity prices.

Andrew Wilkinson is a Senior Market Analyst at Interactive Brokers. ibanalyst@interactivebrokers.com

About the Author
Andrew Wilkinson

Andrew is a seasoned trader and commentator of global financial markets. He worked for several London-based banks trading cash and derivatives before moving to the U.S. to attend graduate school. Andrew re-joins Interactive Brokers following a two-year stretch at a major Wall Street broker-dealer as their Chief Economic Strategist. His coverage of stocks, options, futures, forex and bonds regularly surfaces in global media, and over the last several years Andrew has made many TV appearances on Bloomberg, BBC, CNBC and BNN and Yahoo Finance.

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