GBP/EUR 1.2643 (0.7909)
There was a lack of specific direction through yesterday’s session. European markets were in the green on hope/expectations the ECB will look to boost stimulus, news the ECB are looking at corporate bond purchases has been helping to support the regions equities despite some worse than expected earnings reports. The rally higher in European stocks saw the best two day gains in 16 months, once again without actually committing to anything to action the ECB have provided some short term support. Investors will need to see conviction from the ECB however if this is to continue. The picture from the US was less positive, stocks declined across the board due to a combination of a retrace of Tuesday’s gains, a stronger than expected inflation report and several comments from large investment funds citing continued US growth and above 4% GDP in the coming years. Despite this being good for the overall economy for shorter term markets it raises the potential of an end to loose monetary policy, the USD rallied as markets once again looked towards Fed rate expectations, rising inflation removes one of the Fed excuses not to raise rates. In the overnight session Asian markets traded mostly lower, a better than expected Chinese Manufacturing PMI print did little to boost demand for stocks. In overnight trading the USD maintained its two day demand, while NZD was one of the bigger losers on indications inflation has slowed.
The USD is currently trading in somewhat of a chop zone, on the front of things we have just seen one of the strongest runs in USD strength since the crisis began, an improving US economy and the Fed approaching the end of their QE program led markets and investors alike to believe the Fed may look to raise rates sooner than expected. There are however wider issues affecting the US economy, concerns on Global growth and inflation have raised their heads once again with Europe the epicentre on many of the issues. Looking beyond the headline grabbing economic releases would indicate the US recovery still remains mixed and despite what happens outside the US, raising rates at this juncture is likely to cause concern and risk further recovery. This is one reason the rally in USD has halted somewhat, falling rate expectations has resulted in some USD selling over the last couple of weeks. We still believe the USD will be an out-performer over the next year, especially as Fed policy diverges from the likes of the ECB and BOJ, but rate hikes will play a key role in sustainable USD strength.
Yesterday’s release of the CPI figure threw up a stronger inflation print, rising .1% through September and 1.7% year on year versus 1.6%. This still remains below the Feds 2% target but should inflation continue to rise towards 2%, the market will once again be looking towards the Fed for rate hikes. The other facet of USD strength comes from its safe haven demand, as the world’s most liquid currency the greenback often benefits when risk appetite is low. This has been less evident over the last couple of weeks but the dollar still maintains a haven allure and as such continues to carry the possibility of strength when all else seems bad. Weekly jobless claims, manufacturing PMI and Leading indicator data all cross the wires this afternoon and should set the tone for the US session.
We warned of downside risks to GBP ahead of yesterday’s BOE minutes, last week’s dismal inflation reading carries significant implications for those looking to hike rates and the BOE minutes painted just that picture, once again the MPC were split, only two members voted to hike rates while they were overruled 7-2 to maintain current policy. Despite the persistence of Weale and McCafferty the rest of the MPC appear less confident on recovery, warning that early rate hikes could hamper UK recovery and leave the country vulnerable to shocks. GBP traded lower against the USD while managing to reverse early losses against the EUR, before rallying ahead as the single currency faced its own selling pressures. Retail sales data headlines the UK calendar today with retail sales through September expected to have remained flat at 0%, with the year on year figure falling to 3.4% from 4.5%. This may put further pressure on the pound, especially if retail sales deteriorate further.
The EUR was one of the worst performing currencies of all majors so far this week, the prospect of a broader scope for ECB to purchases assets combined with confirmation the ECB have already begun purchases covered bonds sent the EUR lower as selling picked up. Yesterday confirmed the third straight day of ECB action in the markets as they bought Spanish covered bonds. Monday will reveal the total amount of bonds purchased this week while Sunday will see the release of the banks stress tests. The EUR has got an early lift this morning following better than expected PMI data, the Eurozone composite grew at a rate of 52.2 versus 51.5, while manufacturing confirmed expansion at 50.7 versus expectations of contraction at 49.9. Once again this has just provided a short term lift for the EUR but with stress tests results and further ECB easing expected we remain cautious on any Euro strength.