Daily Insight

The Pound was actually one of the few currencies that rallied against the U.S Dollar yesterday while also making modest gains versus the Euro following reports that UK inflation held above the Bank of England's 2% target for a third consecutive month in December.

Consumer prices unexpectedly rose 2.1% from a year earlier, which was the same as in November and slightly ahead of initial forecasts following a substantial increase in food and energy costs.

Earlier this week, a separate gauge of producer price inflation showed that UK factories increased prices at the fastest annual pace since 1991. Rising inflationary pressures will be closely watched by the monetary policy committee and the reports the week may add to the case for fewer interest rate cuts this year.

As a result, the Pound made modest gains against the majors before news that Tesco plc, the UK's biggest retailer, called for the BoE to lower borrowing costs more aggressively after sales over the holiday period fell short of analyst estimates.

The MPC reduced interest rates in December for the first time in two years as the threat to the economy from higher credit costs outweighed concerns over rising consumer prices.

Therefore, the Bank of England may have to accept that inflation will remain above the 2.0% target this year and continue cutting interest rates in order to prevent economic growth from slowing.

The Euro failed to take advantage of broad Dollar weakness yesterday as investor confidence in Germany fell to the lowest level in 15-years on concerns that a U.S recession will trigger an economic slowdown in Europe's largest economy.

The ZEW centre for economic research released its index of investor and analyst expectations, which fell to a reading of minus 41.6 in January, down from minus 37.2 the previous month.

Elsewhere, a separate report in Germany showed that economic growth slowed to 2.5% in 2007, down from 2.9% in 2006, which was the fastest pace of expansion since 2000.

The report provides a further indication that European economic growth will continue to slow this year but with the ECB still focused on rising inflationary pressures and further monetary tightening, the Euro may continue to test the record highs achieved against the Pound and the Dollar.

The Dollar declined against almost all of the 16 most actively traded currencies yesterday following report that U.S retail sales and producer prices both contracted in the month of December, leading to further speculation that the economy is poised to fall into recession.

Sales at retailers unexpectedly fell in December, dropping 0.4% from the previous month and posting the first decline since June to finish off the worst year of sales since 2002.

A recent statement from the chairman of the Federal Reserve, Ben Bernanke, indicated that policy makers are deeply concerned with the current risks to economic growth and that will surely prompt an aggressive cut in U.S interest rates later this month.

Elsewhere, a separate report showed that producer prices actually fell in December despite forecasts of a modest increase as wholesale prices fell 0.1% following a 3.2% surge in November.

The unexpected drop in factory prices will be closely watched by the Federal Reserve and a drop in consumer prices over the same period may convince the FOMC to lower interest rates by 50 basis points.

Data Released 16th January

UK 09:30 Average Earnings (3 months to November)

UK 09:30 Claimant Count / Unemployment (December)

EU 10:00 Final HICP (December)

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

U.S 13:30 Real Earnings (December)

U.S 14:00 TICs Net Capital Inflows (November)

U.S 14:15 Capacity Utilisation (December)

U.S 14:15 Industrial Production (December)

U.S 18:00 NAHB Housing Market Index (January)

U.S 19:00 Fed Beige Book Published

U.S 15:00 Business Inventories (November)

written by Adam Solomon