The Pound rallied to a high of 1.1153 versus the Euro last night, while the UK currency also made strong gains against the Dollar and all of the 16 most actively traded currencies as an element of risk aversion returned to the market with global stocks falling for the first time this year after six consecutive days of gains.

As we build up to the Bank of England interest rate announcement this lunchtime, the Pound gained for a third consecutive day against the Dollar and also made substantial gains against the higher yielding currencies such as the Australian and New Zealand Dollar despite speculation of another 50 basis point reduction.

The declining sentiment surrounding the outlook for the European economy has weighed heavily on the Euro this week as the single currency consolidates its losses above 1.1000 versus the Pound on bets the ECB will step up the pace of monetary easing as the Euro-zone economy slides deeper into a recession.

In addition, the Euro was further undermined after German unemployment rose for the first time in almost three years and European producer prices plunged by the most since 1981, raising the probability of a further significant rate cut as inflationary pressures moderate.

The jobless rate in Europe’s largest economy rose by a larger-than-expected 18,000 in December as the economic slump prompted companies to shed jobs, while producer costs, which provide an early indication of price pressures in the economy, fell by the most in 27-years.

The Pound has now rallied 6% against the Euro in the past three days alone and there is a number of warning signals coming from Europe that the single currency will come under a sustained amount of pressure over the coming weeks as the market slowly reacts to the weakening economic data.

The UK currency slid 23% against the Euro towards the end of 2008, its biggest yearly drop since the common currency was introduced in 1999, as policy makers cut interest rates at a more aggressive pace than the ECB and the UK economy entered its first recession in 17-years.

A number of economists are now betting against the probability of the Pound reaching parity with the Euro and according to UBS AG "any chance for parity in Euro-Pound is a clear overshot and offers limited risk-reward", while BNP Paribas predicts that the rate will reach 1.1900 by the end of the year.

Nevertheless, the Pound’s resolve will surely be tested in the aftermath of the Bank of England’s rate decision today and policy makers are expected to cut the benchmark lending rate to 1.5% and to the lowest level in the Central Bank’s history.

The Chancellor of the Exchequer Alistair Darling said yesterday that the UK Treasury will have to play a bigger role in setting monetary policy if interest rates head towards zero per cent, suggesting that the Bank of England’s authority will be restrained.

The Dollar declined from a near one-month high against the Euro yesterday, while the U.S currency also came under renewed selling pressure versus the Pound after the ADP employment report showed that the U.S job market deteriorated in December and reinforced concerns over a deepening recession.

The minutes from the Federal Reserve’s last policy-setting meeting showed that policy makers saw "substantial" risks to the economy and pledged to expand emergency loans as necessary to try and stimulate growth and limit the impact of the worst financial crisis since the Great Depression.

The focus is beginning to turn back to economic fundamentals as the market volatility was almost completely dominated by the aggressive swings in risk sentiment towards the end of 2008 but the tone of the ADP report yesterday weakened the Dollar as it provided an indication into the non-farm payrolls numbers later this week.

Data Released 8th January

U.K 12:00 BoE Interest Rate Announcement

EU 10:00 EC Business Climate (December)

EU 10:00 EC Economic Sentiment (December)

- Consumer Sentiment
- Industrial Sentiment
- Services Sentiment

EU 10:00 Gross Domestic Product (Q3 Revised)

EU 10:00 Unemployment (November)

U.S 13:30 Initial Jobless Claims (w/e 9th January)

U.S 20:00 Consumer Credit (November)

written by Adam Solomon

Labels: daily-insight