The Pound rallied for the first time in three days against the Dollar yesterday, increasing 0.4% in London to a high of $1.65, as widespread U.S currency weakness allowed a challenge above significant resistance levels. Sterling also secured support from the overall improvement in global risk appetite, as UK stocks climbed and extended the longest stretch of gains since 2004.
The benchmark FTSE 100 Index swung between gains and losses through the course of the day but the increase in mining companies and gains in purchases of new homes in the U.S contributed to a 0.2% rally on the day. A record number of U.S companies from Goldman Sachs Group Inc to Caterpillar Inc beat analysts’ projections for earnings estimates in the second quarter, increasing an air of confidence in financial markets and weakening the Dollar.
The FTSE 100 has now rebounded 31% since the low on March 3rd, amid speculation that the worst global recession since the Second World War has reached the bottom. U.S new home sales increased 11% in June, the biggest monthly gain in eight years, while the number of unsold properties saturating the market dropped to the lowest level in over a decade.
The Pound also rose 0.4% against the Euro and touched upon a high of 1.16 by the close of the European session last night. The difference between 10-year gilt yields widened to 260 basis points, from 240 basis points at the start of July. The steepening of the yield curve indicates investors increased bets that growth and inflation will begin to accelerate.
Inflation expectations rose for a third straight day as crude oil prices rose to the highest level in more than three weeks. The UK inflation rate will rise at the steepest pace among the Group of Seven nations next year and some economists believe that the Bank of England will be at the forefront of a global push to raise interest rates.
Willem Buiter, a professor at the London School of Economics and a former Central Bank policy maker, said that “the Bank of England could be the first out of the stable. If it goes too early, it might abort a fragile recovery and create a painful appreciation in the Pound. If too late, it may perceived as weak on inflation.”
Higher interest rates will bolster the Pound, which has slumped close to 17% against the Dollar over the past year, and keep a lid on inflation as the economy rebounds from the worst slump in fifty years. Gains in Sterling would, however, come at the expense of exporters, which have reported higher sales on the lower value of the Pound.
The monetary policy committee, led by the governor Mervyn King, will prepare new forecasts this week for the August 6th interest rate decision. After the nine-member panel cut the benchmark interest rate to a record low of 0.5% in March, the UK should see ‘some evidence of positive growth in the second half of the year.’
There are still very serious concerns over the economic outlook and the UK’s debt position, especially after last week’s GDP data, and rating agency Fitch warned that the recovery signs in the economy were probably not sustainable. The near-term downside risks to Sterling persist and reports yesterday indicated that the Bank of England may extend its asset-insurance program until November.
According to Carl B. Weinberg, chief economist at High Frequency in Valhalla, “the only tool the BoE has to influence the economy is quantitative easing, and we see no argument for ending that now. The gilt market is unsure of this, so we expect the bank’s announcement to spark a rally in gilts and a flattering of the yield curve.”
In the event that policy makers would extend or increase the quantitative easing program, the Pound would decline significantly against the major currencies and all eyes will be on the next BoE rate announcement in early August. HSBC Holdings Plc raised its pound-dollar forecast last week for the end of 2010 to $1.75, from $1.60, citing the likelihood that the Bank of England will interrupt its bond buying program next month and raise interest rates before the Federal Reserve.
The Bank of England reported that credit conditions had improved during the second quarter, but doubts over bank lending persisted and there is a very important risk that confidence in the economy will deteriorate further over the next week weeks. However, with the Dollar still on the defensive and risk appetite holding firm, the UK currency has continued to trade above $1.65 this morning.
The Euro maintained a firm tone in Asian trading yesterday and continued to challenge resistance levels through the course of the day. The Dollar fell towards its lowest level in seven weeks versus the single currency, as the global rally in stocks added to recent evidence that investors are shifting their focus towards high-yielding assets.
The Euro benefited from a stronger-than-expected increase in German consumer confidence to the highest level for over a year, while the increase in U.S new home sales further diminished the allure of Dollar denominated assets as a refuge. The U.S currency managed to find support at the lower levels and was able to recover back towards the $1.4230 region last night.
Investors will continue to monitor official comments on the Dollar closely this week, with the U.S Treasury Secretary Timothy Geithner due to hold further meetings with Chinese officials. There will also be a series of press conferences today, which could potentially trigger further market volatility. The Dollar was unable to strengthen back through the $1.42 level this morning and remain susceptible to the underlying confidence in stocks.
Data Released 28th July
U.K 11:00 CBI Distributive Trades Survey (July)
U.S 14:00 Case Shiller House Prices (May)
U.S 15:00 Consumer Confidence (July)
written by Adam Solomon
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