Yesterday's UK CPI was broadly in line with expectations, with the m/m figures indicating a moderate slowing in price pressure. However, as any recent historical graph illustrates, we have seen pullbacks in inflation readings only to see inflation lurch higher weeks later. On one hand it's possible that an extended and entrenched inflationary environment will force the BoE to tightened rates despite UK growth or EU contagion concerns. On the other hand, if the MPC is correct in his assertion that forthcoming EU austerity measures and weak growth will naturally put the brakes on UK inflation, the BoE may decide to resume their previously-shelved QE program. This topic is being hotly debated within ACM and currently we are taking a wait-and-see approach to the GBP and will be examining all forthcoming economic data from the UK.
On the continent, Moody's downgrade of Greece's long-term credit rating to junk status, although widely anticipated, produced divergent market reactions. Yields on troubled EU nations excluding Greece continued to tick upwards this month and the EUR is slowly gaining some strength. Although the correlation is there, we would have expected the two asset prices to be more in tandem. Based on their movements, it seems that FX traders may have shrugged off the rating chop, a serious error which the market may soon correct. The Greek demotion to non-investment grade means that all government bonds issued by Greece are now subject to an extra 5% haircut when used as ECB collateral. Furthermore, we must remember that the only reason the ECB has and will continue to accept these now junk bonds is due to the special exceptions made to help Greece in the near-term.
Spain's short term debt auction was yesterday and went off fairly smoothly. EU auction results continue to be received as EUR positive news, although it's hard to swallow that the good results aren't directly due to market distortion by the ECB. The ECB's aggressive bond purchasing under the Securities Market Program, up to €47 bn from €40.5 bn last week, is not grounded in strategy and has nothing to do with the nation-specific fundamentals and overall prices.
Investors continue to cover short EUR positions, encouraged by the global rally in equities (S&P above 200 day moving average & coming out of a double bottom formation) and the Euro's ability to defy negative news (Germany's dreadful ZEW). Even with this, a prudent investor must understand that the EU debt crisis is far from over and from a fundamental standpoint, we'll continue to be looking for opportunities to short the EURUSD.
And on a final note, as we wait for US economic data and stock markets to open, Merkel's German government took a public relations roundhouse as its being reported that 92% of business and government leader expressed disappointment in the coalition's handling of the crisis as reported by Capital magazine. If she wants to survive the summer she better align herself with the German World Cup squad...ASAP.