The Pound rallied strongly against the Dollar yesterday, briefly trading back above $1.5000 on the session from a low of $1.4780 as global stocks advanced and rekindled an element of risk appetite that reduced demand for save haven currencies like the Dollar, Japanese Yen and Swiss Franc.

The dramatic and often aggressive swings in risk sentiment is driving the currency market at present and the correlation between stocks and the Pound’s performance against the majors is becoming increasingly apparent as the UK currency rallied following a 3.5% gain in the Standard & Poor’s 500 index.

The rebound in equities is supporting Sterling sentiment and the positive reaction in the stock market yesterday limited the Pound’s decline on Monday as the UK currency slipped from a high of $1.5510 versus the Dollar to $1.4800 by the close of the European session.

However, in early trade the Pound came under further selling pressure against the Euro, dropping to a low of 1.1700 after Bank of England policy maker Willem Buiter said that the Central Bank will need to weigh up the risks of triggering a collapse in the Pound as it cuts the benchmark lending rate this week.

In a speech at the Council of Mortgage Lenders annual conference in London yesterday, Buiter said that “the deterioration of Sterling we’ve seen so far has been extremely welcome but there is a risk that it could become a rout.”

The Pound has depreciated 25% in value against the Dollar so far this year and has fallen aggressively this week as investors weigh up the possibility of another aggressive cut in UK interest rates from the current 3.0% as policy makers attempt to limit the impact of a recession and revive spending.

Buiter’s comments reflect the tone of a recent statement by the former Chancellor of the Exchequer Norman Lamont who said last month that the Pound’s “very significant” decline wasn’t yet symptomatic of the crisis but warned that the government may risk triggering a run on the UK currency.

Nevertheless, Buiter went on to say that a currency crisis is a highly unlikely situation and he still expects his fellow policy makers to cut by an unprecedented 150 basis points this Thursday that would take the UK benchmark lending to just 1.5% and to the lowest level since 1951.

The deterioration in UK fundamentals has investors speculating on the prospect of a 200 basis points reduction on Thursday and we can expect the Pound to fluctuate aggressively against the majors in the build up to the monthly announcement.

The European Central Bank and the U.S Federal Reserve are also expected to reduce interest rates from their current levels and Buiter believes that the prospect of zero per cent interest rates in the North Atlantic region is increasingly possible in the new year.

The Pound also remained largely unmoved yesterday amid reports that the cost of hedging against UK losses on government bonds rose to a record level in the market for credit-default swaps, which suggests that investors are losing belief that the Treasury will be able to repay its debt.

In addition, UK construction contracts, which accounts for roughly 6% of gross domestic product, declined at the fastest pace since records began in 1997 as an index based on a survey of purchasing managers slipped to a reading of 31.8 as homebuilders battle the biggest slump in their industry for 25-years.

The seizure in credit markets has crippled the property market and weighed heavily on consumer spending as house prices dropped to the lowest level in three years, while significant falls in new orders, industry output and rising unemployment all contributed to a steady decline in the construction sector.

The Dollar declined by the most against the Euro in a week yesterday, while the U.S currency also lost ground versus the Pound as central banks acted to stem the impact of the global recession and subsequently reduced the appeal of safe haven assets.

The tentative swings in risk appetite will continue to hamper Dollar sentiment as the greenback fell 0.7% versus the Euro on the session as the Austalian Central Bank cut interest rates and is expected to be followed by the Bank of England, European Central Bank and Reserve Bank of New Zealand later this week.

In addition, the Dollar lost support amid reports that the U.S economy is now officially in a recession and may be in the midst of the longest economic slump since the Second World War as the unemployment rate accelerates and credit conditions tighten.

The slump in the economy began almost a year ago after payrolls reached a peak but the pro-active and monumental actions taken by the Federal Reserve means that the U.S are largely ahead of the curve on monetary policy and that will help bring the economy out of a recession quicker than initially anticipated.

Data Released 3rd December

U.K 09:30 CIPS Services PMI (November)

EU 09:00 Services PMI (November)

- Composite Index

EU 10:00 Retail Sales (October)

U.S 13:15 ADP Employment (November)

U.S 13:30 Productivity (Q3 Revised)

- Labour Costs

U.S 15:00 ISM Non-Manufacturing (November)

- Business Activity

U.S 19:00 Federal Reserve Bank Publishes Beige Book

written by Adam Solomon