Wednesday May 12, 2010

A new coalition government for Britain, the prospect of a snap budget to announce where £6 billion in spending cuts will be sourced a dovish inflation report from the central bank are trickling down to weaken the pound marginally midweek. Investors are, however, having a hard time steering a straight path between the prospects of firmer growth combined with below target inflation that offers limited possibilities for monetary policy.

British pound -Bank of England Governor Mervyn King has been campaigning amongst the possible electoral victors over the last year. His mission is to point to the risks to Britain from an ailing fiscal position and conveniently has the blueprint of Greece on the front page of any national newspaper side-by-side with the British election story as his main prop. Today's quarterly review of the prospects for inflation and growth revealed a slightly more optimistic view on growth with the chance of growing recovery lifting the early 2012 pace to 3.5%. While that's undoubtedly good news for a nation struggling to gain traction even as the rest of the world recovered, it comes with an elevated risk warning rooted in the fiscal consolidation of other nations.

Inflation pressures will remain muted and on current projections the rate of inflation would remain below target assuming interest rates followed the market's current path rising from a current 0.5% to reach 1.7% by 2012. In keeping with what's happening in continental Europe, Mr. King stated that the Bank could equally pick-up the Bank's bond-purchase program again having put it out to pasture at the end of the first quarter.

The strengthening growth prospects were illustrated with a decline announced today in the number of jobless claimants by more than anticipated. A report showed a 27,100 decline in the reading of unemployed for April leaving a lower claimant count of 4.7%. But the prospect of greater threats ahead eases concerns that such data even if repeated will force the Bank to restrict monetary policy anytime soon. As such investors cooled towards the pound leaving it below $1.49 having breached $1.50 earlier in the day. The pound currently stands at $1.4887 while a euro buys 85.22 pence today.

Euro - On day three of the ECB's government bond purchase program there are certainly more signs of stability than of success. Peripheral government bond prices have stabilized and spreads are narrowing relative to core government bonds deemed secure from default. Regional equity prices have once again found their footing. However, a steady rise in the price of gold to a fresh peak at $1,245.40 indicates perceived risks remain. Meanwhile the euro remains 3.4% weaker today than at the peak of its euphoric response on Monday.

The single currency traded down to $1.2606 before a surge to $1.2739. Following the release of Eurozone first quarter GDP data showing an annualized pace of expansion of 0.5% the euro is still lower than its prior close standing at $1.2676. Industrial production data for March also showed a health pace of expansion at 6.9% year-on-year with a monthly increase of 1.3%.

U.S. Dollar - The dollar is largely unchanged on an index basis indicating that risk woes have temporarily subsided for now. The March trade deficit at $40.42 billion displayed the largest volumes for both imports and exports since December 2008 as the domestic and international economies speed towards recovery.

Aussie dollar - The Aussie remains caught in a downwards channel associated with the European announcement at the start of the week. The leap in riskier assets and growth-sensitive currencies dragged the Aussie dollar higher on Monday only for lesser subsequent appetite. Investors continue to focus on the prospects for further cooling measures from the Chinese authorities following robust data earlier in the week. The Aussie just rebounded off the top of its channel at 89.80 U.S. cents having rebounded off overnight weakness to 88.89 cents. Data released today showed a slightly larger than predicted decline in home loans, which fell 3.4% during March. The Aussie currently trades at 89.66 cents.

Canadian dollar - It's currently a fourth straight day of gains for the Canadian dollar, which is benefitting from the slightly less cloudy outlook for growth and return to higher prices for commodities. The unit today buys 98.36 U.S. cents.

Japanese yen -The flurry of demand for the safety of the Japanese yen appears to have petered out now that global equity prices have found further stability. Against the dollar the yen weakened to ¥93.26 earlier although losses were limited to ¥93.05 after U.S. trade deficit data indicated a widening of the deficit for March. Against the other majors the pound was the weaker of the three, with the yen notching up gains to ¥138.69 against sterling while falling to ¥118.02 per euro and ¥83.48 per Australian dollar.

Andrew Wilkinson Senior Market Analyst