Daily Insight

The Pound has struggled against the majors this week as the focus switched to the Bank of England interest rate announcement yesterday and the UK currency plummeted to a near three month low versus the Dollar following speculation of a surprise quarter-point reduction.

A recent spate of negative economic reports has undermined the Bank’s optimistic financial stability report as house prices suffered the first annual decline since 1996 and consumer confidence plunged to the lowest level in five years.

The Monetary Policy Committee have lowered UK interest rates on three occasions since the turn the year in a vain attempt to bring some stability to the market while the crisis in credit shows few signs of slowing.

Lenders have been forced to raise mortgage rates and even withdraw some of their best offers from the market as losses linked to the U.S subprime mortgage crisis caused the first run on a UK Bank in nearly a century.

However, the Bank of England elected to keep the benchmark lending rate unchanged at 5.0% yesterday as record high oil prices threaten to fuel inflation. In the wake of the April rate cut, the minutes from the Bank’s last policy meeting showed that two members out of the nine strong committee voted in favour of a greater 50 basis point reduction last month.

The extent of the division with the Bank of England will not be fully exposed until the minutes of the May meeting are released later this month and the Pound may come under further pressure over the coming weeks amid suggestions of a June rate cut.

In the aftermath of the BoE rate announcement, the European Central Bank also held rates unchanged in May and the Euro rebounded from a two month low against the Dollar after the tone of the Central Bank’s accompanying statement showed that inflation remains the top priority.

The resilient of the Euro-zone economy combined with the ECB’s staunchly hawkish stance on inflation has seen the single currency appreciate to record highs against both the Pound and the Dollar this year and the report yesterday showed that policy makers are in no hurry to begin cutting interest rates.

The Chairman of the Central Bank, Jean-Claude Trichet, seemed to ignore the downside risks to economic growth and said that inflation will stay above 3.0% “for a rather protracted period”.

An EU report earlier this week showed that retail sales fell to the lowest level since the series began in 1995 to indicate that consumers are struggling with record high energy costs. However, the European Central Bank will probably hold rates steady at 4.0% over the coming months and retain a tightening bias until the fastest pace of inflation in 16 years shows some signs of slowing.

The Dollar rose to the highest level since February against the Pound and bounced off the support at 1.9500 before a report from the Commerce Department showed that wholesale inventories unexpectedly declined in March following a dramatic increase in oil prices and shorter supplies.

The modest 0.1% drop represents the first reduction since December 2006 and the report provides an indication that consumers are struggling with record high fuel costs while falling home values has restricted spending.

The U.S Treasury Secretary, Hank Paulson, has recently said that the economy is through the worst of the credit crisis but the latest figures show that the gross domestic product grew at the slowest pace since the last recession in 2001.

The Dollar has found some support this week amid speculation that the Federal Reserve will keep rates unchanged this month but a softening in the labour market, rising foreclosures and dwindling confidence may see the Dollar struggle to extend its rally beyond the current levels as the economy stands on the brink of recession.

Data Released 9th May

U.S 13:30 Trade Balance (March)

written by Adam Solomon