Pound gets a battering

It has been a week of bad economic news so far for the UK with manufacturing PMI coming in weaker than expected yesterday and a weak construction PMI reading for April this morning along with meagre money supply growth and mortgage approvals coming in below expectations. All of this points to a sluggish start to the second quarter after disappointing growth in Q1, which is likely to keep the doves at the Bank of England in the ascendency.

Sterling has come under pressure and dropped below 1.6500 versus the dollar. EURGBP is also benefitting and is currently above 0.9000. The weak tone to UK data has eroded sterling’s yield effect and right now German yields are surging above UK yields pointing to further EURGBP strength.

The spread between UK and US 2-year bond yields has declined since reaching a high in February, and it has recently had another lurch lower pushing GBPUSD down from 1.6700 to below 1.6500. This is a large move, and so we would expect there to be more weakness for the pound versus the euro than the greenback in the near-term. Meanwhile, Europe’s yield differential is widening against the UK and the US, which should keep the single currency well supported.

The detail of the UK’s economic data releases this morning is worrying. Construction PMI tumbled, suggesting that a bounce back for the sector after a dismal Q1 is yet to take place. Also, credit growth remains weak, which is weighing on the household sector. This was confirmed by Nationwide data on house prices released earlier that showed prices had fallen by 1.3 per cent over the last year.

All of this makes a rate hike unlikely at this juncture. The UK’s economy is going through a rough patch and rising commodity prices are only adding to consumers’ woes. Higher lending costs would only dampen consumer and economic sentiment further. The next major indicator will be the services sector PMI due on Thursday, which should steal the limelight from the BOE meeting as this is likely to be another non-event as the Bank remains on hold.

In Europe, the single currency has brushed off weaker retail sales for March. Sales tumbled by 1.1 per cent on the month and the annual growth rate is now back at levels last seen in October 2009. However, the FX market is concentrating on the news that Portugal has agreed on a bailout for EUR 78bn with the EU and the IMF, and not the EUR100bn that was rumoured in the media yesterday.

Investors are also concentrating on tomorrow’s ECB meeting. While we, like the consensus, agree that the Bank won’t hike rates, whether or not they signal a rate hike for next month is a closer call. We think they may not hike until July – i.e., a hike once every three months.

However, inflation pressures are building as we saw with yesterday’s PPI figures, which worryingly showed processed food prices rising strongly. This should keep the ECB hawkish. Investors are using the recent pull back in EURUSD to re-enter long positions and we could see back towards 1.4900 in the short-term. If Trichet uses the term “strong vigilance” then we could see 1.5000 in EURUSD by the end of the week.

There are signs that the market is coming back to trade in line with fundamentals like interest rate differentials, which could benefit the high yielders such as the euro, Scandi currencies the Aussie and free-floating emerging market currencies, while weighing on the dollar and the pound.

The weakness in the dollar today has pushed up gold, which is trading around $1,536 per ounce, silver is testing the $42.00 per ounce mark and oil is also higher. Stocks are marginally higher as risk tentatively comes back into the market prior to tomorrow’s central bank meetings and Friday’s all-important non-farm payrolls figures.

Ahead today, watch out for the ADP report that will give us a steer on the amount of jobs created by the private sector last month. Growth has been around 200k per month recently and is expected to come in at 198k for April. Also watch out for a raft of Fed speakers today, see below for details.

In Canada the ruling Conservative party won a majority in Monday’s national elections. This is the first time in seven years the Canadian parliament will not be split and instead has a stable majority government. Immediately the ruling party pledged to bring the government finances under control. This is having no direct impact on the CAD, which is moving in line with risk sentiment. However, in the long-term it could benefit the Loonie as long as fiscal austerity measures don’t hit growth and expectations for rate hikes from the BOC.

Source: Forex.com

04.05.2011