Daily Insight

The Pound declined heavily against the Dollar yesterday and also made moderate losses versus the Euro as a lacklustre performance in the UK service sector has heaped further pressure on the Bank of England to lower interest rates.

The recent spate of negative economic reports has painted a worrying picture for the UK economy as house prices fell for the first time in nine months in September.

According to a report from HBOS Plc, the average cost of a home fell 0.6% from the previous month as higher interest rates and a global credit slump cooled demand for property.

The turmoil surrounding credit markets stems from the U.S subprime mortgage crisis and the impact spurred a run on the UK's fifth biggest mortgage lender, Northern Rock plc. The lender has twice gone to the Bank of England to seek emergency funding in order to stay in business and the uncertainty surrounding credit markets may prompt the BoE to provide some relief to the banking system.

Last month the monetary policy committee elected to hold UK interest rates at 5.75%, the highest in six years, as policy makers attempt to weigh the risks to price stability against a surge in credit costs.

In the accompanying statement released, the BoE declared that "it is too soon to tell how far the disruption in financial markets will impair the availability of credit to companies and households". It is worth noting that it was the first time since May 1999 that the Bank of England have issued a statement after keeping rates unchanged and the last time they did, policy makers lowered interest rates the following month.

As the Euro continues to hold above 1.4000 against the Dollar, the ECB interest rate decision this afternoon will prove one of the main events this week with borrowing costs expected to remain unchanged at 4.00%.

However, the focus, as usual, will fall on the accompanying press conference where the President of the Central Bank, Jean-Claude Trichet, could deliver a statement that delivers sharp volatility.

The ECB have so far been reluctant to comment on the overwhelming strength of the Euro and therefore the market will be looking for any comments designed to slow the Euro's rise.

If Trichet completely avoids discussing the current strength of the single currency then the Euro may well make further gains against the majors as it would send a message that the Central Bank are more concerned with rising consumer prices than with the impact on economic growth.

Consumer price inflation has breached the 2.0% comfort level for the first time in over a year in September and as a result, the ECB may remain staunchly hawkish in the statement this afternoon in order to maintain risks to price stability.

A survey from Bloomberg showed that the Central Bank will wait until April before raising its benchmark interest rate to 4.25% as rising credit costs prompted the ECB to shelve a planned rate increase last month.

The Dollar recovered against both the Pound and the Euro yesterday and made gains for a second day in succession against most of the major currencies amid speculation that the U.S economy added more jobs to payrolls in September.

Last month, seven indicators correctly forecasted a weak payrolls number for the month of August and this time around, six out of those seven including the ADP survey signalled that there will be a sharp improvement.

The ADP employment report confirmed yesterday that the economy added 100,000 jobs to payrolls in September while weekly jobless claims have shown that the number of people out of work and claiming benefits has fallen.

In addition, the components data of the ISM service sector report yesterday showed that the employment component rebounded back into expansionary territory following the first contraction since September 2003.

The prices paid component was also higher in the report and suggests that a weak Dollar is causing renewed inflationary concerns. As a result, the U.S currency headed higher against the Pound and the Euro and may make further gains amid speculation that we could see some official criticism about Dollar weakness at the upcoming G7 meeting.

Data Released 4th October

UK 12:00 BoE Rate Announcement

EU 12:45 ECB Rate Announcement

EU 13:30 ECB Press Conference

U.S 13:30 Initial Jobless Claims (w/e 29th September)

U.S 15:00 Factory Goods Orders (August)

written by Adam Solomon