The Pound continued its upside momentum against the majors, rising to a fresh three week high of 1.1239 versus the Euro, while the UK currency also extended recent gains made against the Dollar after the Bank of England cut its benchmark lending rate to a record low at 1.5% in an attempt to limit the fallout from the worsening recession.

The Monetary Policy Committee, led by the governor Mervyn King, lowered interest rates by 50 basis points, in line with initial expectations, as the Central Bank cut borrowing costs for the fourth time since the global coordinated emergency reductions on October 8th.

In the accompanying statement, the MPC highlighted that “the availability of credit to both households and business has tightened further, pointing to the need for further measures to increase the flow of lending to the non-financial sector, while output is likely to continue to fall sharply during the first part of the year.

The reduction in UK interest rates will limit the Bank of England’s scope to keeping fighting the recession through monetary easing and that may encourage the government to introduce a second stimulus package and inject more money into the banking system through a measure known as quantitative easing.

The Pound rallied strongly against all of the 16 most actively traded currencies as the extent of the reduction not only matched economists’ forecasts but prompted speculation that the Bank of England are nearing the end of its rate cutting cycle and have done what is necessary in order to revive growth.

A 50 basis point reduction is less than hoped by traders and the decision may lead to a sustained period of Sterling strength on interest rate differentials, but in the longer term the Pound may come under further selling pressure and Euro and Dollar buyers may wish to consider placing a stop order to protect against an adverse move.

In the aftermath of the decision, the Pound strengthened as much as 1.8% to a high of $1.5373 versus the Dollar despite rates being cut to the lowest level since the Bank of England’s foundation in 1694 and the UK currency may weaken further over the coming months amid suggestions that rates will be cut to 0.5%.

The UK economy entered its first recession since 1991 last year as the global economy reeled from the worst financial crisis since the Great Depression and the further deterioration in UK economic data has seen traders raise bets that policy makers will cut rates by another 75 basis points by the end of the first quarter.

However, the Nationwide Building Society have already stated that they won’t be passing on any further reductions in rates to the consumer and the government will have to implement less conventional techniques to provide further monetary stimulus.

In an interview with the Financial Times, the Chancellor of the Exchequer Alistair Darling signaled that the Treasury may need to play a bigger role in setting monetary policy if interest rates approach zero per cent and restrain the Bank of England’s influence.

The Euro continued to decline against the Pound yesterday but managed to stem the flow of losses versus the Dollar despite reports that European consumer and business confidence fell to the lowest level on record and unemployment rose to the highest in two years.

An index of business and consumer sentiment slumped to a reading of 67.1 in December from 74.9 the previous month and that represents the worst performance since the EC released its index in 1985, while separate reports showed that the jobless rate rose to 7.8% as companies shed jobs and reduce corporate investment.

The European economy has entered its first recession since the introduction of the Euro in 1999 and a combined rate cut of 1.75% percentage point since early October and billions of Euros in fiscal stimulus measures have thus far failed to reverse the slide in confidence.

The deterioration in European economic data means that the ECB will be forced into cutting interest rates by at least another 25 basis points next week and the Euro has declined amid speculation of a further aggressive easing in rates over the coming months.

The Dollar declined against the Pound and the Euro yesterday as we build up to the U.S employment report this afternoon and the market is anticipating another substantial drop in payrolls to record a cumulative decline of 1.7 million jobs lost in the last four months.

The increase in risk aversion has done little to boost Dollar sentiment as the U.S currency also fell another 1.7% versus the Japanese Yen as the report this afternoon is expected to confirm that the unemployment rate rose in December to the highest level in 16-years.

Data Released 9th January

U.K 09:30 Industrial Production (November)

- Manufacturing Production

U.K 09:30 Producer Price Index (December)

- Output

GER 07:00 Retail Sales (November)

GER 11:00 Industrial Production (November)

EU 10:00 Retail Sales (November)

U.S 13:30 Non-Farm Payrolls (December)

- Average Earnings

- Unemployment

U.S 15:00 Wholesale Inventories (November)

written by Adam Solomon

Labels: daily-insight