by Jon Beddell
Britain’s economy grew by just 0.2% in the first quarter of 2010, much less than the 0.4% expected by analysts. The soft data released on Friday had an immediate impact on sterling, which retreated sharply, dropping back below the 1.6675 resistance that we highlighted in recent reports. This morning the pound is ticking higher as investors, having digested the growth data, decided that there’s a good chance of it being revised higher for the final reading. Also helping to cushion the blow is the fact that retail sales skewed the figures after being hit by the particularly harsh winter.
It’s a big week ahead for the US data calendar, with the latest interest rate announcement from the Federal Reserve on Wednesday, followed by the first quarter growth figure on Friday. Interest rates are almost certain to stay on hold at the record low of 0.25%, but investors will be watching closely for any change in language. Specifically, the Fed’ have made a habit of stating that rates will remain low for “an extended period”. Markets are hanging on to that key phrase as a sign that rates will stay unchanged for the next few months. Dropping that phrase would therefore be the Fed’s warning to the market that a rate rise is on the way, and would negatively impact the high yielding currencies, which at present are continuing to benefit from investor risk appetite and the lack of yield on the US dollar. Analysts are expecting an annualised growth rate of 3.5% in the first quarter, compared to 5.6% in the last quarter of 2009. Interest rates aside, positive US economic data tends to add to the allure of the high yielders. Investors take these US data as a sign of global recovery, and perversely, they sell the US dollar and buy the Aussie dollar as appetite for risk increases along with their confidence in the economic outlook.
The dominant story driving the pound this week is of course, the general election. Interestingly, sterling has actually been rising as the spectre of a hung parliament looms ever larger. The traditional view is that a hung parliament is bad news for the pound because no one party would have the clout to force through financial reforms and tackle the budget deficit. Press comment over the weekend has pointed toward other countries that have run successful coalition governments, in particular Germany, and the current strength of sterling against the euro may support that view.
Australian inflation data on Wednesday is expected to show an annualised inflation rate around 2.8%. On Friday a Reserve bank official said that interest rates are now “close to average”, indicating that the rate tightening cycle may slow. The RBA has raised interest rates several times over the last few months, most recently on April 6th when they raised the benchmark lending rate to 4.25%. The next policy meeting is May 4th, and following Friday’s comments futures markets are now pricing in a 26% chance of another rate hike, down from 40% before the comments were made. If Wednesday’s inflation data is higher than expected, the chances of another rate hike will increase, and that could drive AUD higher. Conversely, a figure on or below expectations should reinforce the “no change” view.
The technical outlook remains negative for sterling. Demand for the Aussie dollar remains very strong, and the fundamentals driving that demand are still very much in place. Stock markets are hitting new highs almost every week (stocks are a barometer of investor risk sentiment) and commodities are also rising. The Australian economy is a net exporter of commodities (including gold) and benefits from higher prices. The price chart is still showing a down trend, and we would need to see sterling capture the 1.6675 level to improve the outlook. We continue to recommend a cautious approach, hedging at least half of any exposure at current levels.
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