Daily Insight

The Pound extended its decline against the Dollar yesterday, dropping to a low of 1.9069 by the close of the European session, but the UK currency again took advantage of broad Euro weakness to break above 1.2800 for the first time since May.

The looming threat of a recession has been graphically highlighted in the recent downturn in UK economic data but the Bank of England has a dual mandate of managing the economy against the upside risks to price stability.

A report from the Office of National Statistics yesterday showed that UK producer prices increased in July at the fastest pace since records began in 1986 and forced policy makers to wait before cutting interest rates even at the risk of an economic slump.

UK factories have been forced to pass on higher costs to the consumer as prices rose 10.2% from this stage in 2007, compared with 10% the previous month, but the report was slightly below initial forecasts and provides some optimism that the recent downturn on commodity prices will filter through to the broader economy.

Nevertheless, the Governor of the Bank of England, Mervyn King, has predicted that record high food and oil prices will double the 2.0% target over the coming months while the economic growth will probably slip into negative territory.

Policy makers are also concerned about second round effects as workers seek higher wages to compensate for the higher cost of living and therefore the MPC decided to keep the main interest rate on hold at 5.0%.

The Pound was little changed against the Dollar in the aftermath of the report but the UK currency lost further ground against the greenback as the unrelenting decline in commodity prices helped boost sentiment for the Dollar.

The focus today will fall on the release of the July consumer price index, which is expected to mirror the tone of the PPI report yesterday and show that the broader measure of inflation accelerated to 4.1% in last month, more than double the government’s yearly target.

The Dollar advanced to the highest level in nearly six months versus the ailing Euro yesterday and also recorded sharp gains versus the Pound amid suggestions that a further drop in commodity prices will continue to boost growth and bring the economy back from the brink of recession.

Concerns that the U.S slowdown is spreading to Europe has prompted investors to reduce holdings of higher yielding assets such as the Pound, Australian Dollar, New Zealand Dollar and pay back low cost loans in Japan and Switzerland as the worsening economic climate brings an increasing element of risk to the market.

The Dollar has subsequently rallied to $1.4899 against the Euro, the highest level since February 26th and further gains are likely as crude oil plunged to a 14-week low amid signs that the U.S economic slump will extend into 2009 and weaken demand for fuel.

Data Released 12th August

U.K 00:01 BRC Retail Sales Survey (July)

U.K 09:30 Consumer Price Inflation (July)

- Retail Price Index

U.S 13:30 International Trade Balance (June)

U.S 18:00 Federal Budget Statement (July)

written by Adam Solomon