The Pound rebounded from a record low against the Euro yesterday but the UK currency slumped to a fresh 2-year low versus the Dollar after the Bank of England and European Central Bank kept interest rates unchanged at their current levels.

The UK monetary policy committee, led by the Governor Mervyn King, held the benchmark interest rate on hold at 5.0% as policy makers attempt to balance the fastest pace of inflation in a decade against the rising probability of the “the worst economic slump in 60 years” according to the bungling UK Chancellor, Alistair Darling.

The Bank’s decision to keep rates on hold could be interpreted that policy makers judge the rising threat of inflation as the biggest threat to the economic growth but the sharp and sustained drop in commodity prices may help bring consumer prices back towards the government’s 2.0% target.

BoE policy maker Timothy Besley recently said that consumer price expectations will moderate over the coming year, almost publicly withdrawing his earlier recommendation for a tightening bias as the economy struggles to cope with the slump in housing and retail sales.

The Pound rose as much as 0.7% versus the Euro after falling to a fresh record low of 1.2218 earlier in the session as the focus now will switch to the minutes of the meeting released later this month while traders speculate on the voting pattern of the nine strong committee and the timing of the next move in rates.

The Pound resumed its downward momentum against the Dollar as reports from HBOS Plc, the UK’s biggest mortgage provider, showed that house prices slumped for the fifth straight month, providing further evidence that the economy is hurtling towards contraction.

Prices fell more than initial forecasts in August to condemn the housing market to the worst performance since the early 1990s and Euro buyers may wish to consider taking advantage of this short-term sterling strength as the pessimism surrounding the UK economy gathers momentum.

The Euro fell to the lowest level against the Dollar this year while the single currency also pared losses versus the Pound after the European Central Bank kept rates on hold and the Central Bank President, Jean-Claude Trichet, said that the Euro-zone are in an “episode for weak activity.”

The latest estimates for gross domestic product in the second quarter showed that the European economy probably contracted in the three months to June and the drop in service sector growth and exports will probably lead to a recession.

The Euro also came under pressure after ECB policy maker and Luxembourg Finance Minister, Jean-Claude Juncker, said that the single currency is currently “overvalued” and a weaker Euro would help increase demand for European based exports and bring the economy back from the brink of contraction.

Trichet didn’t categorically imply a rate reduction was forthcoming in his statement yesterday but the Euro declined on speculation that policy makers were at least willing to acknowledge the risks to economic growth while trying to balance the threat of inflation.

The Dollar continued its unrelenting upside momentum against the majors yesterday as oil prices fell to a five month low and U.S service industries unexpectedly grew in August to signal that the economy is bouncing back despite the slump in housing and deteriorating labour market conditions.

A separate government report showed that first-time claims for unemployment benefits increased 444,000 last week while the ADP employer report showed that payrolls declined 33,000 in August as the focus switches to the monthly U.S job report this afternoon.
Data Released 5th September

GER 11:00 Industrial Production (July)

U.S 13:30 Non-Farm Payrolls (August)
- Unemployment
- Average Earnings

written by Adam Solomon