Daily Insight

The Pound enjoyed a strong intraday rally against the Dollar on Monday as UK producer prices accelerated at the fastest pace in 22-years last month and showed that manufacturers have little choice but to pass on record high raw material costs to the consumer.

The report sparked a mini revival in Sterling sentiment as rising inflationary pressures make it difficult for the Bank of England to begin a prolonged period of monetary easing. However, the Pound resumed the downward momentum against the Dollar today, dropping ever closer towards the yearly low at 1.9388.

The downside momentum also continued against the Euro despite another round of particularly hawkish inflationary data. The Consumer Price Index, which is widely regarded as the broadest measure of inflation, showed that prices rose 3.0% from this stage last year to report the biggest monthly increase since 2002.

Rising food and energy costs have stoked inflation but the report massively exceeded initial forecasts and will force the Governor of the Bank of England to write a letter of explanation to the government. The two reports combined have sparked controversy that the real threat to the UK economy is inflation and the MPC may need to rethink their plans of a June rate cut.

The Pound rose as much as 0.3% against the Dollar in the minutes that followed the report but failed to consolidate on those gains as the Futures market continues to price in a 81% chance of a 25 basis point reduction next month.

The outcome of the June meeting should become clearer after the Bank of England’s quarterly inflation report tomorrow morning, which should be hawkish in tone given the recent commentary from Mervyn King and the dramatic increase in consumer prices.

The Euro has been susceptible to a barrage of weak data in recent weeks and the single currency has continued to decline against the Dollar while taking advantage of broad Sterling weakness to close tonight under the 1.2600 level.

A number of European Finance officials continue to focus on the upside risks to price stability while also recognising that record high food and petrol prices will weigh on consumer spending.

Euro-zone retail sales dropped by the most since records began in March while the cost of oil has nearly doubled over the past year and reached another record high $1.2698 a barrel.

The surge in commodity prices prompted ECB governing council member, Jean-Claude Juncker, to reiterate that “inflation remains a major concern”. That sentiment was reflected by the President of the Central Bank, Jean-Claude Trichet, who said that inflation will remain high for some time, which indicates that the ECB are in no hurry to reduce interest rates.

In terms of economic data, the Euro may come under some pressure tomorrow morning as a gauge of industrial production is expected to show a further softening in output for March.

The Dollar rebounded from a four day losing streak versus the Euro and also registered further gains against the Pound after a government report showed that U.S retail sales exceeded initial forecasts in April and added to speculation that the Federal Reserve will stop cutting borrowing costs.

The resilience in consumer spending will help support economic growth this year amid continued weakness in the housing and non-manufacturing sectors. Sales rose 0.5% last month, following a revised 0.4% increase in March, and the Dollar rallied against most of the 16 most actively currencies amid speculation that economy will pull back from the brink of recession.

Elsewhere, the Dollar stood firm as the Fed Chairman, Ben Bernanke, did his best to supper the renewed optimism surrounding the outlook for the U.S economy. In a speech in Atlanta today, Bernanke said that the turmoil surrounding financial markets is far from over and that the Reserve Bank will increase its monthly auction of emergency funding.

His comments are in stark contrast to a recent testimony from the Treasury Secretary, Hank Paulson, who said that the worst of the credit crisis is behind us.

Data Released 14th May

U.K 09:30 BoE Inflation Report

U.K 09:30 Average Earnings (3 months to March)

U.K 09:30 Claimant Count Unemployment (April)

EU 10:00 Industrial Production (March)

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

- Ex Food & Energy

written by Adam Solomon