The Pound bounced back against the majors yesterday, rising above $1.5400 against the Dollar, while the UK currency also rallied from a low of 1.1675 versus the Euro after gains in stocks and an unprecedented injection of liquidity from the Federal Reserve boosted demand for higher-yielding assets.

The surprising momentum surrounding the Pound saw the UK currency climb for a third consecutive day against the Dollar as the Fed’s plan to encourage lending to consumers and revive spending boosted Asian stocks and some European equity markets.

The volatile swings in risk sentiment continues to reverberate through the foreign exchange market and the Pound has become somewhat of a barometer for risk aversion as the UK currency traded higher after the Fed’s commitment provided a sense of stability in financial markets that encouraged investors to move away from safe haven assets.

That notion is reflected in the Pound’s performance yesterday against the Yen and Swiss Franc but perhaps more significantly the UK currency closed well above the major Fibonacci retracement level at $1.5279 and to that end the Pound could gain as much as 10% versus the Dollar, according to Citigroup Global Markets Inc.

Citing charts used to track and predict currency movements, the Bank said that a rally from near the 76.4% Fibonacci retracement level of the Pound’s upward move from the low at $1.4557 to $1.5249 may indicate that Sterling is gathering momentum with investors targeting a possible gain to $1.5950 and latterly $1.6700.

The Pound also bounced from a daily low versus the Euro after sentiment dwindled following the Chancellor’s pre-budget report yesterday where Alistair Darling proposed a plan that would create the largest budget deficit among the Group of Seven industrialised nations as the government struggles to combat a recession.

The proposal was met with cynicism in the market as the Prime Minister’s plan to raise more tax from the highest earners is unlikely to generate enough money because the rich will contribute more to their private pensions, while converting more income to capital gains, wiping out most of the £1.6 billion to government hopes to raise.

The report from the Institute for Fiscal Studies also highlighted that the Labour Party fought that last election on a pledge not to increase the top rate of income tax from 40% and yesterday’s move marks the first increase in the higher rate since the 1970s.

There is also an argument on the actual benefits of lowering value added tax on small businesses and consumers as the government attempts to bolster confidence and increase spending to revive economic growth.

However, struggling companies will be understandably reluctant to pass on the cut to the public and a somewhat minor drop in VAT will probably give a small boost to consumer spending without being sufficient in bringing the economy out of the current slump.

Elsewhere yesterday, UK stocks gained for second day as the FTSE 100 Index rose 0.4% on the session, led by shares in financial firms, after the Bank of England governor Mervyn King said that policy makers are committed to reviving the flow of credit through the economy.

As a nation, the UK is hugely reliant on borrowing as a means to increase spending but the worsening credit conditions has made banks reluctant to step up borrowing despite a significant easing in the UK libor rate.

In a statement to the UK treasury select committee, King said that the most significant challenge to policy makers is to revive the flow of credit and insisted that the Central Bank “should not shy away from recapitalisation if that proves necessary.”

The Bank of England and the government have been working together to revive economic growth with an aggressive easing in interest rates, the biggest budget giveaway since the 1980s and a multi-billion pound government bailout for struggling financial institutions.

The failure to get banks to step up lending again could potentially increase the risk of a period of deflation and King conceded that stoking credit growth is “more important than anything else at present” and when asked about the possibility of nationalising individual UK banks, King indicated he wouldn’t rule out any such move.

The Euro relinquished earlier gains against the Pound yesterday but the single currency rose above 1.3000 versus the Dollar amid reports that German consumer confidence unexpectedly rose for a third consecutive month and defied concerns over a deepening recession.

The Gfk index for December increased to a reading of 2.2 from 1.9 in November despite initial forecasts of a 0.4% drop and the report provides an indication that consumers are taking advantage of the falling price of oil and declines in inflation.

Elsewhere, ECB governing council member Ewald Nowotny weighed into the argument on the severity of the European economic slump and even declared that the Central Bank should refrain from an aggressive cut in interest rates, favouring a wait-and-see policy.

Nowotny was joined by ECB executive board member Lorenzo Bini Smaghi, who urged policy makers to discuss a more measured response to the current economic slump, saying that “sharp” rate cuts may exacerbate negative sentiment.

The Dollar was susceptible to volatile swings in risk sentiment yesterday as the Federal Reserve took the dramatic steps to unfreeze credit markets by committing a further $800 billion in liquidity as the government seizes up to $600 billion in ‘bad’ debt and sets up $200 billion to support consumer and small business loans.

Policy makers are hopeful that the new initiative will finally bring down interest rates on mortgages and consumer loans, offsetting the withdrawal of private sector financing despite the Reserve bank slashing borrowing costs to 1.0% over the past year.

In terms of economic data, the dwindling sentiment for the Dollar as a safe haven asset drove the U.S currency lower versus both the Pound and the Euro as the economy shrank in the third quarter faster than had previously been anticipated.

Gross domestic product contracted 0.5% in the period from July to September to indicate that the world’s largest economy has sunk deeper into recession as the credit crunch, the worsening housing market and rising unemployment caused a fundamental decline in consumer and business confidence.

Data Released 26th November

U.K 09:30 Gross Domestic Product (Q3 Revised)

U.S 13:30 Durable Goods Orders (October)

U.S 13:30 Initial Jobless Claims (w/e 21st November)

U.S 13:30 Personal Income / Consumption (October)

- Core PCE

U.S 14:45 Chicago PMI (November)

U.S 14:55 Michigan Sentiment (November Final)

U.S 15:00 New Home Sales (October)

written by Adam Solomon