As the disappointment experienced by traders in the wake of the lower than expected US employment numbers eased, markets began the week recovering losses suffered by the pound and the euro versus the dollar. There was no real economic data to trade from the so the pound’s main area of support came from euro advances versus the dollar that came about as risk aversion eased and market confidence improved. Local focus for the week remained on the Bank of England’s rate decision.

It wasn’t all plain sailing for the pound though, Fitch rating agency issued a debt warning on the UK. The rating agency’s statement described the fiscal challenge facing the United Kingdom as “formidable” and said that to tackle the issue would warrant a strong medium term consolidation strategy. The European debt crisis has made markets extremely sensitive to any form of debt concerns and the pound lost over 1% of its value against the dollar as traders sought safety in the US dollar. After the initial shock to the markets wore off, focus returned to the Bank of England and with risk aversion on the euro easing also gave sterling the opportunity to recover although gains were extremely slow.

The Bank of England left interest rate on hold at 0.50% and made no change to the £200bln asset purchase scheme’s value. The announcement was in line with analysts’ expectations and the pound continued its recovery trend. The central bank’s decision seemed to suggest that they were certainly in ‘wait-and-see’ mode as recent inflation indicators have remained above the bank’s 2% target rate expectations have remained unchanged. Additional factors that support the BoE position have been the proposed £6bln in government spending cuts and the impact of a weaker pound.

Economic fundamentals rounded out the week, UK industrial production fell sharply to -0.4% from 2.0% in April weighing heavily on the pound. PPI inflation data further pulled sterling lower coming out at 5.7% while the previous figure was revised up from 5.7% to 5.9% in May. The inflation figures supported the Bank of England’s position on inflation and analysts expectations that interest rates will not increase this year.

Risk aversion based on debt concerns remained on the forefront of euro movements, the latest trigger came from Eastern Europe after Hungarian government officials compared the country’s economic position to that of Greece and claimed the previous government lied about the public finances. The comments sparked renewed safe haven flows from the euro into the dollar in particular. With the euro reaching a 4 year low versus the dollar profit-taking aided the euro and recovery was accelerated after German factory orders for April came out better than expected at 2.8% m/m, analysts forecasts had been for a drop to -0.4% from the 5.1% seen previously. Sentiment towards the euro remains extremely negative and although the single currency made brief gains these were very limited and short-lived. German Trade balance figures showed that the trade surplus in Europe’s largest economy shrank by more than expected while industrial production fell to 0.9% from 4.3% in April. Both the data releases weighed heavily on the euro as concerns were raised over the impact the current economic crisis is having on the EU recovery as a whole.

The European Central Bank announced its interest rate decision on Thursday and kept rates on hold at 1.0% as expected. However, markets were firmly focused on the press conference afterwards as speculation over the lack of unity within the ECB and uncertainty over the direction that the central bank was taking was a major factor in cultivating the negative euro sentiment. ECB President Trichet commented that the governing council expected growth to remain at a moderate pace but inflation forecasts for 2010 were revised up while growth forecast for 2010 were also revised higher, in contrast to this growth expectations for 2011 were lowered, however. Trichet made no comment on the banks recent controversial bond purchases but said that it would keep the unlimited liquidity facility available to banks for a further 3 months. The ECB’s position has not change substantially since its last meeting and as Trichet presented a more united front the euro gained across that board due to confidence have been partially restored. The ECB was not able to completely reassure markets and profit-taking once again set in which pulled the single currency lower versus the dollar as the week ended.

Safe haven demand for the dollar remains strong as investors are still very concerned about debt defaults and the risk of a second global economic downturn due to the crisis in Europe. Fed Chairman Ben Bernanke testified before congress and described the pace of the US recovery as moderate but warned that the recovery would remain a slow and protracted process with unemployment levels expected to remain high. The Fed chairman’s comments supported the reduction in safe haven demand for the dollar. US trade balance figures showed the deficit in the US increase slightly to $40.3bln from $40.0bln but as the data came out just during the ECB press conference the figure were overshadowed and did not affect the improved risk appetite of investors. The Fed Beige book supported the Fed assessment of the US economy showing modest growth in all 12 Fed regions and furthering the dollars downward trend. A rally at the end of the week saw the greenback recovery a large portion of its losses against the pound as weaker UK data pulled sterling lower while investors scaled back risk position versus the euro going into the weekend.

Next Week

Low risk strategies are still going to be favoured by market participants for some time as the European crisis continues to unfold. Europe will keep taking active measures to combat the sovereign debt problem within the EU but it will be some time before confidence is restored. For the UK economic data releases will drive the pound with unemployment, retail sales and inflation data being the main events. The Bank of England has stated the high inflation is one of the main factors in determining the central banks action plan so traders will take specific note of any changes to the CPI data release. UK public spending figures on Friday will also be noted after the debt warning issued by Fitch. The ECB monthly report is unlikely to provide any additional information after Trichet’s press conference last week but the report will not be ignored either, analysts keep looking for clarity on ECB strategies and the monthly inflation report will to be looked at for this very reason. For the US, weekly jobless figures and inflation data will hold market attention.  

Economic Data Releases