Pound slides, Bank of England foresees no tightening

IB FX Brief: Inflation report sends British pound sliding

The Bank of England today dampened recent speculation that it will meet market demands for any interest rate increase and in the process sent the pound tumbling. A positive session for Asian equities maintained pressures on the Japanese yen, which fell against 12 of its 16 major partners.

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British pound – Consumers have raised their expectations for inflation at the end of the year, while stalling output at the end of 2010 has complicated the Bank of England’s own predictions. In Wednesday’s quarterly inflation report the central bank said that the growth trajectory over the next couple of years is lower than when it last made its prediction. It also said that inflation would most likely fall below the 2% target in two years’ time but said that the risks of an inaccurate call were greater. The market’s insistence that monetary policy must rise have further dented the growth profile amidst deeper divisions among the voices within the Monetary Policy Committee. What we heard today from the Bank is that it has no intention of raising interest rates given the outlook for growth and the fact that, whether those hawkish inclined like it or not, the factors affecting current prices are transient and will diminish beyond the middle of 2011. For the Bank’s voting members and its economists the next few months is likely to feel like a white-knuckle ride as they await the thrill of monthly inflation data points. The pound slid by 175 pips to $1.6050 following the report as investors unwind bullish bets predicated on prospects for rising yields. The pound also fell against a strengthening euro, which today buys 84.12 pence. Coincidentally, the number of people out of work rose according to a report for January released today as 2,400 additional claimants registered for benefits. Analysts had predicted a small decline in the reading.

U.S. Dollar – An unchanged dollar index means the dollar feels as though it’s less in focus these days as the global economy recovers. Rising equity prices have the potential to unsettle the dollar since the market tends to view accompanying inflation as less likely to rattle the Federal Reserve than most other central banks. However, that theory is slowly eroding as increasingly bankers eyeing inflationary trends seem content to brush off first-round impacts of events stemming from commodity costs. Only if inflation filters through to wage increases will they be worried. This seems to have leveled the central bankers’ playing field somewhat in recent weeks leaving the dollar less disadvantaged with traders prone to play the upside on positive economic data. The dollar has a busy economic calendar today with January industrial production expected to rise for a third month in a row albeit at a slower pace than previously. The dollar index is marginally weaker at 78.53.

Japanese yen – An upbeat assessment from the Bank of Japan earlier in the week and a continuation of the buoyant mood amongst regional equity investors elevated demand for higher-yielding bets in turn souring demand for the yen. The unit fell against 12 of its 16 trading partners keeping the dollar on an upwards trajectory. Today the dollar buys ¥83.75.

Aussie dollar – Enthusiasm for the Aussie was tempered despite a strong start that saw the unit rally from Tuesday’s three-week low at 99.44 U.S. cents following a Moody’s warning over the country’s banks. Moody’s said it might downgrade banks from both Australia and New Zealand on account of a lack of access to overseas capital. The Aussie earlier reached $1.0016 cents before sliding back below parity where it currently buys 99.93 cents. Investors were earlier buoyed by a leading index compiled from December data intended to look ahead at the health of the economy six-months forward. The Westpac leading index rose 0.8% rising from unchanged in the prior month.

Euro – The euro is building a series of higher lows following its start of the week slide to $1.3428. Sentiment towards the euro has changed little with the bigger picture unchanged although the failure of a weak market bias to build on the many negative aspects surrounding the prospects for the future of the Eurozone had short investors forced to pay a new weekly high to cover their short positions earlier. Testimony to that point is the fast subsequent reversal of fortunes thereafter. The euro reached $1.3570 overnight only to plunge back to $1.3501. The next downside test is Tuesday’s weakest point and comes in at $1.3476. A break of here would open up a challenge to Monday’s low.

Canadian dollar – The Canadian dollar dragged in immediate response to midweek data showing a far smaller increase in manufacturing sales for December than had been penciled in. In the event sales rose 0.4% compared to predictions of a gain for 3%. However, the Canadian unit was also caught in the crossfire of a barrage of U.S. data within which producer prices rose faster than expected and housing starts were buoyant. The U.S. dollar strode forward against the majors transforming the performance of its index from lower to higher on the day. In response to an improved tone for the U.S. economy the loonie pared its immediate decline and remains steadfastly firmer on the day buying $1.0129 U.S. cents.

Andrew Wilkinson

Senior Market Analyst

ibanalyst@interactivebrokers.com

Note: The material presented in this commentary is provided for informational purposes only and is based upon information that is considered to be reliable. However, neither Interactive Brokers LLC nor its affiliates warrant its completeness, accuracy or adequacy and it should not be relied upon as such. Neither IB nor its affiliates are responsible for any errors or omissions or for results obtained from the use of this information. Past performance is not necessarily indicative of future results.

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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