Daily Insight

The heightened sense of speculation surrounding the Bank of England interest rate announcement reached fever pitch yesterday as the UK currency posted further losses against the majors in anticipation of the second rate cut in just three months.

The nine-member Monetary Policy Committee, led by the governor Mervyn King, elected to reduce the benchmark lending rate to 5.25% in response to slowing consumer spending and the steepest decline in house prices for over a decade.

The MPC stopped short of adopting the same aggressive policy as the Federal Reserve and decided to lower rates by just 25 basis points. The move had been factored into the market for the past month and in the accompanying statement policy makers said that they need to balance risks to economic growth against the threat of rising inflationary pressures.

The tone and language used in the statement seems to indicate that the Bank of England will continue cutting interest rates this year while how fast and how much will depend predominantly on inflation expectations.

The Bank also acknowledged that rocketing food and energy prices are expected to rise "quite sharply" this year but a slowing economy and falling interest rates are likely to "return inflation to target in the medium term".

Nevertheless, the UK's benchmark rate is still the highest among the Group of Seven nations while the Pound fell 0.3% against the Dollar in the aftermath of the announcement.

Elsewhere, the economic data released prior to the rate announcement did little to boost Sterling sentiment as UK manufacturing unexpectedly fell for a second consecutive month in December.

The renewed appetite for the Dollar gathered momentum yesterday as the U.S currency erased its losses for the year against the Euro while also rising 1% in value versus the ailing Pound.

As the ECB admitted that Europe won't escape the fallout from the U.S economic slowdown, speculation intensified that the Fed's decision to lower borrowing costs on two occasions in January will put the U.S economy on course to recover faster than the Euro-zone.

However, a number of recent economic reports points to further deterioration in services and consumer spending while the number of Americans filing unemployment claims fell less than forecast last week.

The Euro declined for a fourth straight day against the Dollar and also registered sharp losses versus the Pound after the Chairman of the European Central Bank, Jean-Claude Trichet, signalled that policy makers may be forced into cutting interest rates as economic growth cools.

Following the ECB's decision to leave interest rates unchanged at 4.0% this month, the Euro erased the earlier gains made against the Dollar and is poised to record the biggest weekly loss in 18 months.

The staunchly hawkish stance of the Central Bank has been the foundation for the Euro's appreciation towards fresh record highs against both the Pound and the Dollar but Trichet's comments yesterday may pave the way for the first cut in nearly five years.

Just over a week ago the ECB had been talking up the resilience of the Euro-zone economy in the face of U.S recession and the need to prevent inflation from spiralling out of control.

While global stock markets tumbled Trichet was calling for calm and stressed on many occasions that Central Bank's should prevent second round effects and maintain price stability during times of turbulence.

Data Released 8th February

GER 11:00 Industrial Production (Decmeber)

U.S 15:00 Wholesale Inventories (Decmeber)

written by Adam Solomon