Pound rallies, euro could face pressure

The British Pound surged to a high of 1.5669 during the European session as the Bank of England dropped its dovish outlook for inflation, and the exchange rate may continue to trend higher going into the U.S. trade as price action bounces back from the 200-Day SMA at 1.5498.

Talking Points

  • Japanese Yen: Mixed Against The Majors
  • Pound: BoE Votes 8-1, Andrew Sentance Dissents
  • Euro: Construction Expands For First Time Since 2008
  • U.S. Dollar: Risk Trends To Drive FX Market On Thin Event Risks

The BoE meeting minutes showed the MPC voted 8-1 earlier this month to hold the benchmark interest rate at 0.50% and maintain its asset purchase target at GBP 200B, while board member Andrew Sentance continued to dissent against the majority and pushed for a 25bp rate hike for the third consecutive month.

The central bank said “growth had been surprisingly robust” despite the ongoing slack within the real economy, and saw a risk for inflation expectations to be de-anchor over the coming months as price growth continues to hold above the government’s 3% limit. At the same time, Mr. Sentance argued that “economic conditions had improved over the past 12 months and the inflation outlook had shifted sufficiently to justify beginning to raise rates gradually,” and went onto say there “there was evidence that firms had found it easier to pass through price increases” as the recovery gathers pace. As a result, the central bank reiterated that the committee stands ready to move monetary policy in either direction as it aims to balance the risks for the economy, but expects the substantial amount of spare capacity to bear down of inflation as households and businesses continue to face tightening credit conditions. As the economic outlook remains clouded with uncertainties, the BoE is likely to maintain a neutral policy stance throughout the remainder of the year, but the stickiness in price growth could spur an increased split within the MPC as it maintains its dual mandate to ensure price stability while fostering full-employment.

The euro fell back from a high of 1.2908 to maintain the narrow range carried over from the previous week, and the single-currency could face increased selling pressures going into the North American session as investors scale back their appetite for risk. Meanwhile, the Basel Committee on Banking Supervision said the new capital and liquidity measures could weigh on economic activity and sees GDP curbed by an average of 0.04% over the next four and a half years, but went to say growth will return “to its baseline path in subsequent years” as the region emerges from the recession. Nevertheless, the economic docket showed construction in the Eurozone expanded 2.7% in June following a revised 0.7% decline in the previous month, while outputs increased at an annualized pace of 3.1% to mark the first positive reading since February 2008. As growth prospects improve, the European Central Bank may see scope to reemploy its exit strategy over the coming months, but at the same time, the Governing Council may look to support the economy going into the following year as the governments operating under the single-currency withdraw fiscal support.

The greenback weakened against most of its major counterparts, with the USD/JPY paring the previous day’s advance to reach a low of 85.18, and risk trends are likely to drive price action in the currency market throughout the day as the economic docket remains fairly light for Wednesday. Equity futures are foreshadowing a flat open for the U.S. market even as most of the European indices track slightly lower on the day, but a rise in risk aversion would stoke a rebound in the dollar as the reserve currency continues to benefit from safe-haven flows.

David Song is a currency analyst at FXCM.

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