Daily Insight

The Pound held firm against the Euro yesterday following a better than expected report on the UK Service sector, which increased in September after declining for four consecutive months with input and output prices falling back in line with other recent revisions on consumer price inflation. The manufacturing and service sector reports this week have both shown robust growth in the last month, which has only fuelled speculation that the Bank of England will raise interest rates this year with the next scheduled announcement at midday today. It is becoming increasingly difficult to successfully predict whether the BoE will lift interest rates this month but in light of the recent omission from the Office of National Statistics, we can expect the MPC to hold rates in October and adopt a 'wait and see' policy with a probable hike in November. In addition, a 20% drop in oil prices since mid-July has eased inflationary pressures and all of these factors concerned, we expect the Central Bank to keep rates steady at 4.75%. However, we can never discount the possibility that the BoE will indeed raise interest rates today particularly following the surprise rise in interest rates in August and if that scenario was repeated this month, we can expect the Pound to make significant gains against both the Euro and the Dollar. The minutes from the meeting will be released on the 20th October and investors will have to wait until then to gauge how the eight-strong committee voted.

The Euro came under pressure against the majors yesterday, falling 0.1% against Sterling and a further 0.4% versus the Dollar after the purchasing manager's index on the European service sector fell by more than expected last month primarily due to a rise in unemployment and higher borrowing costs. The index fell to a reading of 56.7 in September, which is the lowest reading in the last 10-months although a level above 50 indicates growth and the report is unlikely to stop the ECB from raising Euro-zone interest rates at midday today. Rising rates and a planned tax increase in Germany next year is clouding the economic outlook while the International Monetary Fund expects Euro-zone growth to slow to 2.0% next year while a significant drop in energy prices has pushed inflation back below the Central Bank's comfort zone. The European Central Bank are notoriously transparent in terms of monetary policy and following the tone of the press conference last month, we fully expect interest rates to be lifted by a further quarter-point to 3.25%. While inflationary pressures are seemingly moderating, the economy has expanded at the fastest pace since 2000 this year, which may prompt the ECB to raise rates beyond this month. Therefore, the tone and language used in the accompanying press conference this afternoon will take on added significance and if the chairman, Jean-Claude Trichet, reiterates that 'strong vigilance' is still required, we can expect the Euro to strengthen significantly as speculation mounts of a further rate hike in December.

The Dollar made gains in early trading yesterday following comments from the president of the Kansas City Reserve bank, Thomas Hoeing, who reiterated that U.S inflation was still too high in a seemingly vain attempt to rekindle interest rate speculation. However, by mid-afternoon the Dollar had relinquished much of the gains against Sterling after a report from the Institute of Supply and Management showed a larger than expected drop in activity in the U.S service sector. Industries expanded at the slowest pace in more than three years last month, which correlates with the dramatic slump in the housing market this year. The non-manufacturing index fell to a reading of 52.9, the lowest level since April 2003, and the report will only emphasise concerns that the U.S economy is losing momentum going into the fourth quarter as the service industries account for almost 90% of gross domestic product. The Dollar came under further pressure against the Pound as a separate report showed factory orders and production is also slowing, excluding transportation, orders fell 0.7% in August, the biggest drop in 6-months.

Data Released 5th October

UK 12:00 Bank of England Interest Rate announcement

EU 12:45 European Central Bank Interest Rate announcement

U.S 13:30 Initial Jobless Claims (w/e 30th September)

written by Adam Solomon