GBP: Will UK Inflation Report Kill the Rally?

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Daily FX Market Roundup 08-06-12

GBP – Will UK Inflation Report Kill the Rally?
Dollar – Fed Officials Talk Tapering
NZD: Looking Ahead to Employment
AUD: Shrugs Off RBA Rate Cut
CAD: Sees Sharp Improvement in Trade
EUR: Lifted by Stronger Factory Orders
JPY: Extends Gains Against the Dollar

GBP – Will UK Inflation Report Kill the Rally?

On the eve of the Bank of England’s Quarterly Inflation report, the British pound ended the day unchanged against the U.S. dollar as traders nervously hold onto their current positions. Last month, BoE Governor Mark Carney made it clear that big changes are coming and all eyes were trained on tomorrow’s Quarterly Inflation Report where Carney will deliver his first major public appearance at the accompanying press conference. When the minutes for the July meeting were released, they said that the central bank is preparing to unveil a “mixed strategy” involving forward guidance on the path of interest rates. Given that all members of the monetary policy committee voted for steady policy that month, the expectations are high for a major change in policy. However the big question for FX traders is whether the change which will also be significant for sterling.

To start, the Bank of England will most likely tie their plans for interest rate changes to a threshold. We already know that the central bank has an inflation target of 2.0% but they may take a page out of the Federal Reserve’s book and introduce an unemployment rate target of 7%. They could also discuss timing that would quality as calendar date guidance. Of course, the BoE is not expected to give a specific date but they could suggest a year when rates will start to rise. None of this would be particularly impactful on the currency especially since the central bank will most likely add that everything is dependent on data. However the impact on sterling would be significant if the central bank targets unemployment lower than 7%. With the current rate of unemployment at 7.8%, a lower unemployment target would imply that the central bank plans to keep rates on hold for the next 2 years. Sterling could also give up its recent gains if the central bank says that interest rates will be not be increased if inflation is less than 1.5% which would be a further commitment to low rates.

Yet economic data has been good with service, manufacturing and construction sector activity accelerating. When the central bank met earlier this month, they said “recent economic news has supported the MPC’s forecast for a gradual recovery.” As such, they could raise their 2013 and 2014 GDP forecasts, which may lend support to the currency. Therefore unless the Inflation Report is overwhelmingly negative with no upward revisions to GDP or Inflation and more aggressive changes in guidance, the impact on sterling could be limited. In fact, sterling could even rally. However we can’t forget that Mark Carney has been brought in to stimulate growth and could err on the side of dovishness.

Dollar – Fed Officials Talk Tapering

Better than expected U.S. economic data and hawkish comments from Federal Reserve Presidents failed to lend much support to the greenback. The U.S. trade balance reached its best level since October 2009 and yet the dollar barely budged. Investors were not impressed that the trade deficit narrowed 22.4% to -$34.2 billion from -$44.097 billion. The underlying improvements were ideal with exports rising 2.2% to a record high and imports falling 2.5%. This is a quiet week for U.S. data but investors will continue to look for clues on how soon the Federal Reserve will taper. Unfortunately the outdated trade balance plays only a small role in their decision. Earlier this morning, Fed President Lockhart said 180k to 200k increases in jobs could lead to a reduction in bond purchases and he wouldn’t rule out a tapering move in October. While Lockhart is not a voting member of the FOMC this year, this is the first time that October has been put forth as a viable option. Previously, the focus has been on the September and December meetings because of Bernanke’s press conference but the central bank could also hold a special press conference after a move in October – an option that shouldn’t be ruled out completely. Fed President Evans, who is a voting member of the FOMC this year agrees that the Fed is likely to taper in 2013 and end QE in mid-2014. He would “clearly not rule out a September tapering.” As one of the more dovish members of the FOMC, his aggressive views on tapering suggest that September is still the more likely option. No U.S. economic reports are scheduled for release tomorrow leaving investors to focus on a speech by Fed President Pianalto, who is not a voting member of the FOMC this year.

NZD: Looking Ahead to Employment

All 3 of the commodity currencies appreciated against the greenback today. While the Australian dollar was the main focus, attention will shift to the New Zealand and Canadian dollars over the next 24 hours. We start the Asian session off with New Zealand unemployment numbers. Unfortunately employment conditions are expected to deteriorate, which could force NZD to reverse its gains. The currency received a lift overnight from reports that the economic impact of the milk contamination is smaller than expected. According to Finance Minister English, the products affected by China’s ban are worth only NZD 125 million or 1% of their dairy shipments because 95% of their shipments to China are whole and skim milk powders. Later in the day, Canada will release its IVEY PMI report. The improvement in trade activity boosted expectations for the manufacturing sector. Like the U.S., Canada enjoyed a sharp improvement in trade during the month of June. The country’s trade deficit narrowed to –CAD 0.47B from a downwardly revised –CAD 0.78B. Exports rose 1.4% while imports increased 0.6%. Like its Southern neighbor, exports reached a record high thanks to increased demand for cars and aircraft. While Canada’s trade balance is slowly crawling back towards a surplus, the fact that the export dependent nation is running a deficit at all means that the economy is still suffering. To the surprise of many traders, the Reserve Bank of Australia’s decision to cut interest rates by 25bp to 2.5% turned out to be positive for the AUD. The neutral tone of the RBA statement and the lack of update on China or their outlook for the mining sector suggest that the central bank is not considering additional rate cuts at this time. However despite a 15% decline in the AUD/USD this year, they still believe that the exchange rate is too high which suggests that they would be more comfortable with the currency at 0.85 to 0.80 cents against the U.S. dollar.

EUR: Lifted by Stronger Factory Orders

The euro traded higher against most of the major currencies today after German factory orders rose the most in eight months, a sign that the region’s largest economy may not be doing as poorly as recent numbers suggest. The International Monetary Fund said, “Given the size of Germany’s economy and its large external imbalances, stronger and more balanced growth in Germany is critical to a lasting recovery in the euro area and global re-balancing.” The IMF’s executive board is torn on advocating for more action by German Chancellor Angela Merkel’s government. The IMF said, “Most directors supported the current policy stance for this year, although some saw scope of a proactive stimulus, given the significant risks to the outlook.” The European Central Bank Executive Board Member Peter Praet said today that the ECB stands ready to reduce interest rates further if inflation outlook warrants. He said, “This conveys the notion that we have not reached the lower bound on our key interest rates.” According to Praet, “We have not run out of ammunition. Further cuts in policy rates remain an option for the ECB if the outlook on price stability so warrants.” In July the ECB issued a forward guidance saying that the interest rates are set to remain at the current level or lower for an extended period of time. The extended period time has not been clarified. Praet said, “Our forward guidance has contributed to more stable money market conditions and has helped to anchor market expectations more firmly.”

JPY: Extends Gains Against the Dollar<.h5>

The Japanese Yen continued to rise against the U.S. dollar and euro. The International Monetary Fund urged the Japanese government to fully implement Shinzo Abe’s “three arrows” growth strategy to bolster growth and to escape deflation in its annual assessment of the economy. The IMF also urged the nation to reduce its debt. With Japan’s piling debt, the lack of debt reduction strategy could result in a shift in market sentiment and a large sell-off of government bonds. The report said, “Implementing the planned increase of the consumption tax rate from 5 to 10% by 2015 is a necessary first step in this direction, but substantial additional consolidation measures to take effect after 2015 will also be necessary.” The first arrow of the strategy was launched in April, which increased monetary easing by the Bank of Japan and helped accelerate growth and demand. The IMF urged the country to proceed with the third arrow, which involves medium-term fiscal and growth plans. The IMF anticipates growth to reach 2% in 2013 and inflation to gradually increase to 0.7% by the end of the year. However, the IMF warned that Japan faced significant risks from both international and domestic factors. A report from the Cabinet Office revealed that Japan’s leading index fell in June from 110.7 to 107.0. Japan’s coincident index also fell from 106.0 to 105.2. The Cabinet Office said these reports could be a sign that the economy is losing its momentum.

Kathy Lien
Managing Director

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