Weekly Currency report

From Peter-John Theuninck, Currency Analyst at Baydonhillfx

Central bank meetings in Europe and the United Kingdom took centre stage last week as market participants expected changes in policy form both the European Central Bank and the Bank of England. Before the policy announcements the market had a number of manufacturing and service sector activity related data releases to review which served to heighten policy expectations.

Manufacturing activity in Germany fell more than expected while the country’s services sector slipped in contraction territory, France on the other hand saw an easing of contraction trends but the data certainly supported expectations that an interest rate cut may be warranted. The European Central Bank (ECB) ‘obliged the market’ and cut its primary lending rate by 25 basis points to 0.75% but in a surprise move the UE central bank also cut its deposit rates to zero in an effort to force commercial banks not to hoard money at the ECB and rather lend it to the market. The move saw a selloff in the Euro and market movements of over 0.5% against most currencies.

Data from Britain was a little more upbeat but quite mixed in its outlook, manufacturing activity showed a surprise increase in activity while the services sector indicated a marginal slowdown but neither of these releases change expectations for an increase in quantitative easing. A £50bln increase to the asset purchase scheme was already priced into the market when the Bank of England announced the increase and had very little effect on the Pound. It was in fact the policy actions by the ECB that triggered a rally in the Pound against a basket of currencies, movements versus the Dollar were an entirely different story as the greenback rallied across the board.

The central bank meetings in Europe and a shortened trading week due to the US Independence day holiday injected added volatility into the market last week. Safe haven demand for the Dollar remained strong and kept the US currency trading to the upside throughout the week as investors sought to minimise their risk exposures. US employment data also focused on strongly as the job market is a key factor in determining US monetary policy, positive releases from the ADP employment and Non-farm payrolls reports pushed the Dollar higher and allowed the currency to close the week near  a one month high on cable.  

This Week

Market participants have had to contend with increased volatility after last week’s central bank events in Europe and will continue to look at overall economic conditions to gauge the level of risk they are prepared to accept on EU and UK investments.

The German economy is still taken as the primary gauge for EU economic recovery and stability and the recent slew of softer fundamentals has raised concerns that Europe’s largest economy was showing increased signs that the EU sovereign debt crisis is negatively impacting the country’s activity. Today’s release of lower trade surplus figures for Germany has compounded the effects of last week’s manufacturing and services PMI data which is keeping the single currency trading lower across the board.

European Finance Ministers are meeting later this week but investors are sceptical that any progress will be made at the meeting despite Spain being given a 1-yr extension on meeting the 3.0% deficit target set for the country.

German inflation figures are scheduled to be released on Wednesday and the figures have been forecast to remain unchanged y/y for June. The data will no doubt have been anticipated by the European Central Bank when it cut interest rates last week and could very well have little impact on the Euro. We would in fact expect market risk strategies to be the primary driver behind currency market movements this week and the single currency is thus expected to see further downside pressure.

The Dollar is undoubtedly being favoured in part due to its status as a safe haven currency but also due to more optimistic economic data still being seen from the United States. A good example of the contrast in economic stability was the positive US employment numbers seen last week, a job market recovery is very important to the Federal Reserve Bank and last week’s number have eased expectations of additional stimulus being introduced by the US central bank.

The US Dollar is primed for profit-taking due to its fairly sharp appreciation in value and while we could see some weakness as a result of such trading we still see the Dollar being favoured over other major currencies. Economic data releases will not be ignored but those of consequences will only be released at the end of the week, weekly jobless claims are forecast to maintain a more positive outlook while sentiment indices from the University of Michigan are forecasted to show improvement as well. The late week data release will likely mean investor sentiment and expectations over the EU finance ministers meeting will dictates the currency’s early movements.

The Bank of England increased the value of its asset purchase program to ensure that the Britain remains well buffered against any shocks from the Euro-zone and to prevent any further weakening of its economy. Economic data has been a little softer than investors would have liked and raises ongoing concerns regarding the UK recovery, analysts are again looking at a long protracted period of recovery for Britain. Minor data releases are scheduled for this week and even though the figures will not be ignored and will affect the value of the Pound they are not expected to change the market’s overall perception of a weaker UK economy or result in a change it trends. Sterling weakness against the Dollar is expected to continue, with periods of profit-taking giving the Pound some support, and against the Euro further gains are limited as the markets become more oversold on the single currency and global risk aversion caps any Sterling appreciation potential.    

Economic Data