European participants have taken a pragmatic view of the Fed's discount rate hike.  While the move had initially prompted a rush of speculation that it might herald the start of a round of tightening by the Fed, the softer tone of the USD during European hours suggests this is not a universally held view.  The minutes of the Feb FOMC, published just a day before the discount rate hike, had made it clear that a 25 bp increase in the discount rate would be a technical adjustment and would not be indicative of the timing of a move to a less accommodative policy stance.  It is as likely today as it was yesterday that the Fed will continue with its exit policies during the summer months before hiking rates in the second half of this year.  USD supply has been noted this morning vs the EUR, the JPY and GBP.   European equities indices have pared their opening losses.  

While the reaction to the Fed's discount rate move may have been overblown, the USD should continue to find support on the improvement noted in US economic data recently.  The Fed is still likely to be off the starting blocks with a rise in rates months before the ECB or the BoJ.  This should support the present trends towards USD gains vs the JPY and the EUR.  Added to this, uncertainty about the future of EMU in light of the deficit concerns of Greece et al could pressure EUR/USD for months.  The Greek government are being cornered by pledges from the EU of no new money and resistance from the electorate against wide scale pay, pension and employment cuts.  This must be forcing Greece to question whether it can afford to remain within EUR.  The blowing out of Greek bond yields has already lessened one of the key advantages that Greek's position within EMU had provided.  Without this advantage the attraction of a devalued drachma must be rising.  European PMI data this morning suggested that the recovery is continuing in Q1, but since the pace is still fairly slow, the data brings little respite for the EUR outlook.  

The outlook for cable took another hit this morning on the release of worse than expected UK Jan retail sales (-1.2% m/m).  Poor weather and the VAT rise will have contributed but there is no getting away from the fact the consumer sector was horribly weak in Jan.  These data force the question of how sustainable the UK economy recovery will be in 2010 if fiscal support is rapidly withdrawn.  This debate can only intensify ahead of the general election (likely May).  There may be a fine line between the right amount of fiscal austerity and positive growth that would bolster the pound but given the risks on either side of this could swing as far as a debt crisis (if no austerity is introduced) and a double dip recession (if too much austerity was seen), in all likelihood sterling buyers will remains scare into the spring suggesting further downside pressure is in store for the pound.  The break of key technical support at GBP/USD1.5540 was a very bearish technical signal for the pound.  

RBA governor remarked today that the Australian economy has less scope than previously expected for robust growth without inflation.  Hopes for a March rate hike had already been stoked by the minutes of the Feb policy meeting which showed the decision to then hold rates steady as being finely balanced.  Although it is off the day's lows, AUD/USD has been unable to clamper back above 0.900 this morning in light of the pull back in risk appetite following the Fed's move.
Canadian retail sales will be of interest this afternoon,  US CPI data is also due.
Jane Foley
Research Director