Weekly Currency report

From Peter-John Theuninck, Currency Analyst at Baydonhillfx

As the Euro rallied on the back of continued covering of short euro positions by speculators, the Pound followed suit making consistent gains versus the Dollar although it’s performance against the single currency was considerably more volatile.

The Pound fell sharply ahead of the release of UK Q4 GDP figures and the minutes from the Bank of England’s (BoE) last monetary policy meeting. UK Q4 GDP showed growth declined more than expected at -0.2% against a forecast of -0.1% and the Q3 release of 0.6% q/q, the contraction of the British economy led to increased fears of a possible second recession although Sterling rebounded on the back of the release recovering earlier losses as ‘profit-taking’ set in. The Bank of England minutes indicated the members of the MPC voted unanimously to hold the target for asset purchases steady at £275bln and to keep interest rate unchanged at 0.5 percent but some members expressed concern that they would undershoot the 2% target which meant further expansion of asset purchases was likely to be required. The Pound continued to appreciate as the week ended, Bank of England member Miles made what was seen as more hawkish comments to the markets on Friday. Miles said it was “presumptuous” to think further quantitative easing in February was a done deal and expressed confidence that inflation would fall as had been forecast by the UK central bank.

Speculative covering of short euro positions kept the single currency trending higher across a basket of currencies but as the week progressed these flows began to diminish. Markets remained hopeful that Greece would come to an agreement with its private investors on a debt swap deal, this kept investors favouring a ‘risk-on’ approach towards currency markets that aided the Euro as well as other more ‘high risk’ currencies. Economic fundamentals within the Euro-zone, in particularly Germany, pointed to continued underlying stability within the EU but debt concerns created uncertainty amongst investors who fear that a lack of sovereign funding could quickly destabilise the region.

The US Dollar fell across a basket of currencies due to speculative currency movements and anticipation of the US Federal Rese4rve Bank rate decision. The Dollar extended those losses after the US central bank pledged to keep interest rate at its current ultra-low 0-0.25% levels until late 2014, 18-months later than had initially been expected. Fed Chairman Bernanke also said the central bank may consider further monetary easing through bond purchases due to ongoing concerns over a possible global knock-on effect  that the European debt crisis could have on global markets. Investors and traders alike had hoped that the recent string of positive US data might have resulted in a more bullish Fed so markets reacted with some disappointment to the distinctly dovish tones.

This Week

Comments from the Bank of England saw markets scaling back their expectations of an increase in the UK central bank’s asset purchase program at the end of February but the possibility of such action is still widely expected. To that end economic fundamentals will be closely watched to see if there is any cause for concern regarding a continued softening of the British economy. Key focus for the Pound will be on the release of the various purchasing managers indices (PMI), the PMI manufacturing index being the most important of these release. UK manufacturing activity has been forecast to show an improvement with the sector moving back into expansion territory, analysts are only forecasting a slight improvement and while one can expect such a release to be positive for Sterling the effect are likely to be short-term.

Market participants will certainly be looking at the data in context of trends for the UK economy but the figures are unlikely to significantly reduce expectations that further stimulus measures will be introduced in February. Uncertainty surrounding the European debt crisis will still be a factor to consider as it plays on investor sentiment, markets were disappointed at the onset of this week after it was confirmed Greece had still not reach an agreement with private investors on a debt swap. Any movements towards increase demand for safe haven currencies such as the Dollar would likely have a detrimental effect on the value of the Pound.

German CPI inflation figures showed consumer price pressures in Europe’s largest economy ease in line with expectation which leaves the European Central Bank in a stronger position to keep monetary policy on hold. Retail sales and PMI manufacturing data from Germany will be the main focus for fundamentals from the Euro-zone and the data is expected to indicate stable economic activity. This leaves only the ongoing debt problems within the EU as a potential negative factor for the single currency. Greece has yet to reach an agreement with private investors on them taking a write-down on Greek bonds and the EU and International Monetary Fund (IMF) is again putting pressure on the Greek government to introduce further austerity measures in order to secure the next round of bailout funds. This leaves investors quite nervous and after 2 weeks of gains the Euro is more likely than not to weaken against the US Dollar.

Speculators cannot be ignored though as we saw last week, short-term profit-taking trends set off by economic data events are likely to again introduce a great deal of volatility to currency markets.

The main focus this week for the Dollar will be the jobs sector with the ADP employment report and the Non-farm payrolls numbers being released on Wednesday and Friday respectively. In addition to the main employment data releases we also have the weekly jobless claims numbers to look at, last week’s figures were slightly weaker on the headline release but the overall trend in data remained positive. Analysts will be keen to see if the positive trends seen so far continue, and should this be the case, the Dollar will continue to be seen as a safe bet for investors looking to limit their risk exposure.

The final data release to keep an eye out for will be the release of the ISM non-manufacturing index, activity within the US service sector is expected to have increased for the month of January further strengthening the US Dollars safe haven status. Speaking of safe haven flows, debt events in Europe and their effect on the single currency will again continue to have a knock-on effect to movements in the Dollar.

Economic Data