The world of foreign exchange appears to be caught in something of a halfway house at present where global economic recovery is intertwined with inflationary pressures. With most visitors to the inn showing enormous appreciation for the chance to stop and rest as they survey the height to which they have climbed, they find alongside themselves a companion with whom they are less comfortable. As investors remain busy building an ever-higher edifice glorifying this recovery, they drive exchange rates based on the assumption that the cost of borrowing needs to be adjusted in order to play out their dreams.
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U.S. Dollar – High yielding currencies had a fire lit beneath them after Chinese inflation data fell short of expectations and removed a barrier to rising risk appetite. The dollar index softened but the assault was far from broad-sided. The Aussie for example couldn’t make its rally stick, while the euro is also reversing an earlier gain. Data due for release later on Tuesday may well show that U.S. retailers saw increased demand from consumers for the seventh month in a row and advancing a monetary tightening at least in the mindset of dollar bulls. The index slipped 0.2% to 78.47 ahead of key data on Tuesday.
Japanese yen – One region where recovery accompanied by rising prices would probably be quite welcome is Japan, where falling prices have restrained spending by consumers in the expectation that they can buy more if they wait. On Tuesday the Bank of Japan left monetary policy untouched, but for the first time in nine months raised its expectations for growth. The Bank said that “as the growth rate of the global economy has started increasing again led by emerging and commodity-exporting economies, Japan’s exports and production are showing signs of resuming an uptrend.” And there was more evidence of recovery in process with industrial production data for December showing a 3.3% monthly gain to leave output higher by 4.9% year-on-year. Monthly capacity utilization rose 3% through December. But despite an improved outlook it’s highly unlikely the Bank of Japan is set to tighten monetary policy either this year or next. With the Federal Reserve more likely to finally respond to a pick-up in activity and price pressures, it’s the dollar that’s exerting its authority over the yen with the greenback reaching ¥83.75 in today’s session.
Aussie dollar – Minutes from the RBA overnight largely reiterated what was either mentioned in last week’s policy statement or in testimony from Governor Stevens. The Bank said that a “slightly restrictive policy” was appropriate in light of rising incomes from the commodities boom. The RBA also noted an improvement in global data since the start of 2011, but this was countered by domestic consumption habits where consumers were restraining their spending habits. The Aussie rose to $1.0058 U.S. cents but later eased to 99.96 cents. Some of the loss of wind is owed to China’s consumer price index, which rose by 4.9% year-on-year through January. Although the reading remains elevated, it is below a market expectation of 5.4% and takes some of the pressure off the central bank to raise policy further to cool the world’s number two economy. The Aussie outpaced the Japanese yen rising to ¥83.80 and reaching a nine-month high, while it shed almost 1% against the British pound.
British pound – A 0.1% increase in January’s CPI was the first in years for an economy used to seeing goods on sale at the start of the year. The increase brought the year-over-year rate of consumer price inflation to 4% and twice the target rate forcing the Governor of the bank of England to write an open letter to the Chancellor. He must do this quarterly when inflation exceeds the government’s 3% threshold of tolerance. Sterling was calm following the actual data but received the release of the Governor’s letter with some gusto. The Governor wrote, “The MPC judges that attempting to bring inflation back to target quickly risks generating volatility in output and would increase the chances of undershooting the target in the medium-term.” But the pound’s response seemed to display a level of distrust in that explicitly clear explanation as though the words sounded hollow. The pound rose to as high as $1.6144 for a gain of a penny on the day. Wednesday brings the Bank’s quarterly economic assessment and will shed further light on the matter.
Euro – The euro is higher but appears trapped in a narrow half cent range from $1.3500. Comparing fourth quarter Eurozone and German GDP data released clearly shows the lead the German economy commands over its partners. The region’s largest economy grew by 4% for the year compared to 2% across the region. French GDP also disappointed falling short of expectations at 1.5% and down from 1.7% through the third quarter. Investor confidence rose for a fourth month in Germany according to a ZEW survey, which returned a reading of 15.7 for February after 15.4 last month. This economic sentiment survey is intended to measure activity six months forward acting as a leading indicator.
Canadian dollar – The Canadian unit dug its heels in early after rising prices for crude oil and gold were spurred by spillover protests in Bahrain where a second opponent to the government was killed, ironically at a funeral. The loonie faces no economic data tests of its own but rose to buy $1.0137 early Tuesday.
Andrew Wilkinson is a Senior Market Analyst at Interactive Brokers LLC
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