Daily Insight

The U.S Dollar fell to the lowest levels in almost a month versus the Pound and the Euro yesterday despite some positive U.S data and comments from the new Treasury secretary, Hank Paulson, who reiterated his desire to see a 'strong dollar' in the coming months. In recent weeks, speculation has been building that the Federal Reserve would hold interest rates at 5.25% for the first time in 18-months as economic growth shows signs of slowing in the second quarter results. However, the personal income and expenditure report, which is the Fed's preferred measure for inflation, showed that price pressures remained in June as U.S consumer spending increased by 0.4% on the month while the inflation gauge accelerated by 2.4% from the same month last year, which is the most since September 2002. In addition, the ISM index showed that growth in U.S manufacturing unexpectedly rose in July, rising to 54.7 from 53.8 the previous month, which is the first increase since April.

Therefore, some investor's are speculating that the Federal Reserve will need to lift interest rates to 5.50% in the their monthly FOMC rate announcement next week while elsewhere, the monthly U.S job report on Friday will take on added significance on which direction policy makers will take. In light of the strong inflation data and the pro-dollar comments from Mr Paulson you would expect the Dollar to stage a modest rally against the majors but instead we closed above 1.8700 against Sterling last night and we may see further Dollar weakness this afternoon, particularly if the ADP Employment report comes out under expectations.

The Pound received a timely boost yesterday ahead of the Bank of England interest rate decision tomorrow as Nationwide House Prices showed a better than expected increase in July with prices rising a robust 0.8% despite forecasters anticipating a more modest 0.4% gain. The recent reports on the UK housing market have all displayed signs of growth and will therefore give the BoE scope to lift borrowing costs. However, the CIPS manufacturing survey, which has showed growth in the sector in recent months, unexpectedly fell lower to a reading of 53.8 in July despite initial forecasts predicting a modest drop towards 54.5. UK manufacturing accounts for a large percentage of GDP growth and policy makers will be concerned that a drop in output would hinder economic growth in the latter part of the year. Without any significant data released in the UK today, the focus will be squarely on the BoE rate announcement tomorrow and if policy makers elect to hold rates at 4.50% for the 12-month running, we can expect to see the Pound weaken in the short-term.

The Euro remained relatively unchanged versus the Pound yesterday despite a host of positive economic data released int he Euro-zone as German unemployment fell to the lowest level since August 2004 in the figures for July as the jobless rate dropped to 10.6%. Elsewhere, the Purchasing Manager's index show that European manufacturing expanded at the fastest pace in over 6-years in July, which has further emphasised sentiment that the ECB will need to quicken the pace of monetary tightening to cope with rising inflationary pressures. In addition, the manufacturing report has provided evidence that higher interest rates are not having a negative impact on the economy as economic growth continues to flourish while rising inflation is still a concern for policy makers. It is widely expected that the ECB will raise interest rates to 3.0% tomorrow and the chairman, Jean Claude Trichet, may announce that the Central Banks intends to continue tightening rates in the coming months. There is a sparse supply of economic data released in the Euro-zone today but the Producer Price Index for June should provide a gauge on inflation and it is anticipated that prices have increase by just 0.2% from May.

Data Released 2nd August

EU 10:00 Producer Price Index (June)

U.S 13:15 ADP Employment Report (July)

written by Adam Solomon