Talking Points

  • Japanese Yen: Mixed Despite The Rise in Risk Aversion
  • British Pound: BoE Maintains Current Policy
  • Euro: Risk For Contagion Intensifies
  • U.S. Dollar: Wholesale Inventories, Monthly Budget Statement on Tap

Currency traders showed a bullish reaction to the Bank of England interest rate decision as the British Pound bounced back from a low of 1.6009, and the sterling may continue to recoup the overnight losses as investors speculate the central bank to gradually normalize monetary policy later this year. The BoE held the benchmark interest rate at 0.50% while retaining its asset purchase target at GBP 200B, but the central bank refrained from releasing a statement as they maintained their current policy. Nevertheless, investors expect the MPC to hike the key rate by at least 75bp over the next 12 months according to Credit Suisse overnight index swaps, and interest rate expectations may gather pace over the coming months as U.K. policy makers hold a hawkish outlook for future policy.

However, as economic activity unexpectedly contracts in the fourth-quarter, there could be a growing split within the MPC as the fundamental outlook for the U.K. remains clouded with high uncertainty, and the committee may look to preserve its wait-and-see approach throughout the first-half of 2011 as it aims to balance the risks for the region. As the GBP/USD narrowly maintains the upward trend from the previous month, the pound-dollar may push higher going into the end of the week, but the small rebound in the exchange rate could be short-lived as risk aversion flows back into the currency market. In turn, the GBP/USD is likely to trade within the narrow range from earlier this week, and we may see the pound-dollar fall back towards 1.6000 as risk sentiment continues to dictate price action for the major currencies.

The Euro pared the advance from earlier this week, with the exchange rate slipping to an overnight low of 1.3614, and the single-currency may continue to lose ground throughout the North American trade as investors scale back their appetite for risk. Nevertheless, the European Central Bank reiterated that monetary policy remains appropriate in its monthly report, and repeated that the risk for inflation could move to the upside as they expect price growth to hold above the 2% for most of 2011. Economists now anticipate inflation in the Euro-Zone to grow at an annualized pace of 1.9% this year amid an initial forecast for a 1.5% rise, while economic activity is expected to expand 1.6% during the same period versus earlier projections for a 1.5% advance in the growth rate. However, as the governments operating under the fixed-exchange rate system face rising borrowing costs, market participants speculate Portugal to tap the European Financial Stability Facility as bond yields climb above 7%, and the single-currency is likely to face additional headwinds over the near-term as policy makers maintain a relaxed approach in addressing the sovereign debt crisis. In turn, the EUR/USD should continue to retrace the near-term rally, and we may see price action settle around 1.3500 going into the end of the week as the risk for contagion continues to bear down on market sentiment.

The greenback rallied across the board on Thursday, with the USD/JPY advancing to a fresh monthly high of 82.87, and the U.S. dollar may continue to regain its footing during the North American trade as investors scale back their appetite for risk. As equity futures foreshadow a lower open for the U.S. market, the rise in risk aversion could gather pace, and the greenback may look to recoup the losses from earlier this week as it benefits from safe-haven flows. Nevertheless, the economic docket is expected to show wholesale inventories increasing 0.7% in December after contracting 0.2% in the previous month, while the monthly budget statement is anticipated to show a $55.6B deficit in January following the $42.6B shortfall in the month prior. However, currency traders may show a muted reaction to the data as risk aversion flows back in the market, and the rebound in the greenback may gather pace as fears surrounding the global outlook bears down on investor sentiment.

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To discuss this report contact David Song, Currency Analyst: dsong@fxcm.com