Daily Insight

The Dollar fell against both the Pound and the Euro last night following the Federal Reserve's decision to lower its benchmark interest rate by half a percentage point in an attempt to pre-empt an economic slump and thusly spur the biggest rally in U.S stocks since 2003.

The chairman of the Fed, Ben Bernanke, has seemly adopted the same approach as his predecessor Alan Greenspan in reducing rates to avoid a slump rather than waiting for one to occur. The unprecedented decision to lower rates by 50 basis points has followed the increased turmoil surrounding credit markets in the wake of the U.S subprime mortgage crisis, which has threatened to curb the pace of global growth.

The cut may also help alleviate the worst housing recession since 1991 while the Fed also cut the discount lending rate and provided the biggest confidence boost to financial markets that investors could have hoped for.

In the accompanying statement, policy makers, who voted unanimously to lower rates by half a percent, took a non-committal stance on future policy and left the door open for further monetary easing.

Therefore, Fed fund futures are currently pricing in another 50 basis point cut before the end of the year as the risks to economic growth clearly outweigh the risks to inflation. As a result, the Dollar has tumbled against the majors, touching a fresh record high against the Euro and trading back above the $2.00 barrier versus the Pound.

The Euro rose to a record high of 1.3985 versus the Dollar last night as the diverging interest rates expectations in Europe and the U.S make the Euro a far more attractive commodity for investors with the market looking to test the 1.4000 level over the coming days.

However, with the single currency also heading towards a two-year high against the Pound, ECB policy makers may be getting increasingly concerned that a strong Euro will eventually curb economic growth, such is Europe's dependence on exports.

In terms of economic data, the Euro failed to make further gains against the Pound yesterday as a report from the ZEW centre of economic research showed that German investor confidence had fallen by more than expected in September. The survey for investor and analyst expectations dropped to the lowest level since December as rising defaults on U.S subprime mortgages pushed up credit costs.

The decision from the Federal Reserve to cut U.S interest rates brought the Pound back above the $2.00 level last night as severe Dollar weakness overshadowed growing concerns about the UK economy.

The furore surrounding the UK's fifth biggest mortgage lender, Northern Rock, has forced the Bank of England to release emergency funding to commercial banks and financial institutions as the credit slump threatens to curb consumer confidence.

In addition, a report yesterday showed that the annual rate of UK inflation had unexpectedly fallen to the lowest level since March 2006 last month with consumer prices rising just 1.8% from a year earlier compared with 1.9% in July. It is the second month in succession that inflation has remained under the government's 2.0% target and gives the Bank of England the scope to reduce interest rates in response to a worsening credit market slump.

UK inflation has slowed from a decade-high of 3.1% in March to just 1.8% less than six months later and with signs that the housing market is slowing, the Central Bank may have little choice but to lower the benchmark lending rate over the next quarter.

Therefore, the focus this morning will fall on the minutes from the Bank of England's last policy-setting meeting where the MPC elected to hold interest rates at 5.25% and a unanimous decision may be negative for the Pound.

Data Released 19th September

UK 09:30 Minutes 5-6 September MPC meeting

U.S 13:30 Consumer Price Index (August)

U.S 13:30 Housing Starts (August)

written by Adam Solomon