Following on from last week, the resurgence of risk appetite was reflected in the positive four day run in U.S stocks and a degree of consolidation on foreign exchange markets subsequently ensued as the Pound clawed back some gains versus the Dollar, rising to a high of $1.5510 despite fears of a crippling recession.

Short term money market rates are also showing some signs of improving liquidity and it will be interesting to see if the Pound can sustain its momentum over the coming week as the UK currency also made significant gains against the Euro, rising above 1.2100 despite speculation of a 75 basis point reduction in UK interest rates.

The Pound posted its biggest weekly advance against the Dollar in almost three years as a rebound in global stocks rekindled an appetite for higher-yielding currencies and that sentiment is perfectly illustrated in the UK currency’s performance against the Yen and Swiss Franc.

The FTSE 100 Index advanced by the biggest weekly amount in almost a month and the aggressive swings in risk sentiment is driving the currency market as the Pound lost 3.4% against the Dollar and 3.5% versus the Euro in November amid suggestion that the UK recession is deepening and forcing policy makers to cut interest rates again.

Nevertheless, the rebound in equity market has provided some strong and much needed support to Sterling in the near term at least but traders are increasingly pessimistic about the longer term prospects for the Pound and feel that the surprisingly rally will run out of steam towards the middle of the week.

Crucially the Pound also closed well above the so called Fibonacci retracement level at $1.5279 on November 25th and the UK currency has stubbornly remained well above this level, which indicates that Sterling could gain as much as 10% in value against 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 seizure in global credit markets and a deepening recession has sapped confidence in the UK economy and the Bank of England have had little option but to cut interest rates on four occasions over the past year from 5.50% to just 3.0%, the lowest since 1955, and investors are speculating on the size of the reduction this Thursday.

According to the BoE Governor Mervyn King and a host of policy makers, the biggest issue for the UK economy is getting banks to step up lending and actually pass on the full extent of the recent cut in UK interest rate cuts in an attempt to revive spending.

UK consumer confidence held at close to the lowest level in more than 30-years in November as the pessimism surrounding the outlook for growth intensified and falling home values elevated concerns about a recession that has deterred spending.

An index of sentiment rose one point to a reading of minus 35 and UK consumers are reeling from news about a poor economy in general, while mounting concerns over the escalating number of job losses means that the government’s decision to value added tax may still fail to boost spending.

The declining outlook for the UK economy and the looming prospects of the worst recession in decades has caused investors to raise bets on the probability of a period of deflation over the over months and that may undermine the Pound and prevent the current rally from gathering momentum.

Therefore, Euro and Dollar buyers would be well placed to take advantage of the current rate of exchange or at least place a working stop order in the market around $1.5250 versus the Dollar to protect against an adverse move this week.

The European Central Bank are also expected to cut its benchmark lending rate by 50 basis points this week and resist investor expectations of a bigger reduction in order to tackle the Euro-zone recession that may be as deep and prolonged as the slump in the UK.

ECB policy makers convene in Brussels on Thursday and will probably cut rates to 2.75% but there is some speculation that the governing council members will vote for a bigger reduction as the inflation rate plummets at the fastest pace in almost two decades and companies shed jobs.

Last week, Executive board member Lorenzo Bini Smaghi warned that "sharp" reductions in rates may exacerbate rather than oviate a worsening market sentiment and historically the Central Bank has adopted a more gradual approach to monetary easing, preferring to take their time in anchoring market and consumer expections accordingly.

The Dollar declined sharply against both the Euro and the Pound last week as a strong element of risk appetite returned to the market but it will be interesting to see if that trend is maintained over the coming week as fears for the global economy intensify and year end factors increasingly come into play.

In addition, there is a host of key data releases in the U.S this week with manufacturing and services ISM surveys scheduled, while the focus will fall on the non-farm payrolls numbers for the same month and the preliminary readings for retail activity over the Thanksgiving holiday.

Data Released 1st December

UK 00:01 Hometrack House Prices (November)

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

U.K 09:30 Consumer Credit (October)

U.K 09:30 Mortgage Applications (October)

U.S 15:00 Construction Spending (October)

U.S 15:00 ISM Manufacturing (November)

written by Adam Solomon