The Pound continued to rally strongly against the Euro yesterday, rising above 1.1000 for the first time in nearly three weeks, while the UK currency also made further gains against a basket of currencies amid speculation that the Bank of England’s aggressive easing in rates will revive the UK economy.

The FTSE 100 index of UK shares also climbed for a sixth consecutive day and the Pound advanced as much as 2.2% versus the Euro after a plethora of weak European economic data highlighted the problems facing the ECB.

Europe’s manufacturing and service industries contracted for the seventh consecutive month in December as the economy slipped deeper into a recession and the Euro weakened amid fears that the European Central Bank will need to cut interest rates aggressively next week.

In addition, the Pound was looking increasingly “oversold” against the common currency and the recent correction in the exchange rate indicates that investors are becoming pessimistic about the outlook for Europe and believe that the UK economy will recover faster from the current slump.

The momentum surrounding the Pound follows the single biggest intraday advance since the Euro’s debut in 1999 and investors are speculating on the possibility of a further upside move towards 1.1400 in the short-term.

The UK currency also rallied to a high of $1.4990 versus the Dollar, despite falling to a low of $1.4505 earlier in the session, after UK service sector growth contracted at close to the fastest pace in at least 12-years last month, while an index of house prices fell by the most since 1991.

According to a report from the Chartered Institute of Purchasing and Supply, UK service companies fell to a reading of 40.2 last month, up marginally from 40.1 in November, which represents the lowest level since the gauge began in 1996.

Elsewhere, the average price of a home in Britain fell to an annual 15.9% in December, according to a report from the Nationwide Building Society, while consumer confidence dropped to the lowest level since 2004 and rising unemployment curtailed the pace of consumer spending.

Tighter lending restrictions have also hampered retail sales and a record number of UK retailers are expected to join Woolworths Plc and close stores this year as higher costs and a drop in revenue force companies to collapse into administration.

The Bank of England are expected to lower the benchmark interest rate to just 1.5% on Thursday, the lowest level in its history, as policy makers attempt to combat the first recession in seventeen years and the Prime Minister Gordon Brown plans to unveil new measures this month to try and bolster the economy.

The tone of yesterday’s economic data will only increase concerns surrounding the outlook for growth and economists predict that interest rates will be cut to 0.5% this year as banks plan to tighten lending conditions further and mortgage approvals plunge to the lowest level since records began.

The Pound may still fall towards parity with the Euro as the BoE cuts rates quicker than the ECB and therefore Euro buyers would be well placed to work a stop order in the market to protect against an adverse move.

Nevertheless, the Euro is under pressure in the short-term and the single currency also declined to a three week low versus the Dollar after the dire sentiment of European economic data raised the probability of another substantial cut in borrowing costs next week.

A composite index of manufacturing and service industries dripped to a record level in December, while the harmonised index of European consumer prices showed that the inflation rate fell to the lowest level in over two years as oil prices plunged and consumer spending slumped.

Consumer price inflation in the Euro-zone slowed to 1.6% from 2.1% in November, which was in excess of initial forecasts, and below the Central Bank’s 2.0% ceiling for the first time since August 2007, giving the Central Bank yet more scope to reduce interest rates from the current 2.5%.

The Euro had strengthened dramatically against the majors in December following comments last month by the ECB chairman Jean-Claude Trichet, who said that policy makers were wary of being “trapped” with interest rates too low, while Bundesbank President Axel Weber reiterated that he would “like to avoid” taking rates below 2.0%.

Nevertheless, the deepening economic slump may encourage the ECB to extend the current pace of monetary easing and investors are already factoring in a 25 basis point reduction in January with a further cut next month.

That sentiment was echoed yesterday by governing council member Vitor Constancio, who said that “any risks to inflation settling well below 2.0% must be preventively contained with interest rate reductions”.

The Dollar is expected to extend its recent rally against the Euro but the U.S currency declined heavily versus the resurgent Pound amid a plethora of weak economic data with factory orders, pending home sales and U.S service industries all contracting further into negative territory.

The ISM index of non-manufacturing companies was actually higher than initial forecasts at a reading of 40.6 in December but was still the worst on record, while the National Association of Realtors released an index of pending home sales that slumped 4% in November.

The reports combined will only serve to increase concerns that the economic slump is gathering in momentum and is putting pressure on Congress to quickly enact President-elect Barack Obama’s fiscal stimulus package that hinges on tax and spending proposals aimed at middle-class households and businesses.

Obama met with congressional leaders from both parties at the Capitol on Monday to try and shore up support for the two year plan, estimated to be worth around $775 billion to boost the ailing U.S economy and stimulate growth after the worst financial crisis since the Great Depression.

Data Released 7th January

GER 09:00 Unemployment Rate (December)

EU 10:00 Producer Price Index (November)

U.S 13:15 ADP Employment (December)

written by Adam Solomon

Labels: daily-insight