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The Pound fell sharply after the preliminary second quarter GDP figures showed the economy contracted by 0.8% which was more than double the median estimate of 0.3%. Sterling reached as high as 1.6544 before the release on prevailing risk appetite, but a record 5.6% drop in the annual reading for GDP saw the GBP/USD drop over a 100 pips but is starting to regain its footing.

Talking Points
• Japanese Yen: Testing 95.00
• Pound: GDP Contracted By Record Amount Over 12 Month Period
• Euro: German IFO and EZ PMI Exceeded Expectations
• US Dollar: University of Michigan Consumer Confidence On Tap


Pound Dips on Record Contraction of U.K. GDP in 2Q, Euro Finds Support On Improving Outlook

The Pound fell sharply after the preliminary second quarter GDP figures showed the economy contracted by 0.8% which was more than double the median estimate of 0.3%. Sterling reached as high as 1.6544 before the release on prevailing risk appetite, but a record 5.6% drop in the annual reading for GDP saw the GBP/USD drop over a 100 pips but is starting to regain its footing. We also saw the index of services fall by 1.0% as the sector that accounts for more than 70% of GDP continues to show weakness.

The depth of the contraction for the U.K. economy will make it formidable for the economy to return to growth and although we are seeing signs of stabilization there may be more work ahead for the BoE to ensure a recovery. Therefore, we may start to see markets begin to price in additional quantitative easing efforts from the central bank which they could announce at their August policy meeting. Taking a look at the GDP breakdown we see that every component declined over the three month period led by a 2.1% drop in transport & communication. However, manufacturing saw its pace of decline slow to 0.3% from over 5.0% the past two quarters. Thus, we could see traders decide to focus on the signs that the economy is stabilizing and see a muted impact from the backward looking measurement. The 20-Day SMA at 1.6372 continues to provide support and unless we see the GBP/USD fall below the 50-Day SMA at 1.6260 we could see the pair remain range bound.

The Euro has steadily climbed throughout overnight trading as improvements in the German IFO and Euro-Zone PMI readings added to the prevailing bullish sentiment. German business sentiment rose to 87.3 from 85.9, which was the highest since October as both the current sentiment and future outlook saw improvements. Meanwhile, the PMI composite rose to 46.8 versus expectations of 45.3 as both the service and manufacturing sectors showed a slower rate of contraction. The sectors are on the verge of growth as record low interest rates and government stimulus is helping stabilize the economy. ECB member Athanasios Orphanides said Concerning prospects for 2010, after a period of stabilisation, a gradual rebound is anticipated in the euro zone. This could be a sign that the central bank is done with their efforts to revive the economy and we could see them officially cap their covered bond purchase program at the current 60 bln euros which could start to raise interest rate expectations and lend further support for the single currency.

The dollar continues to be pressured as risk appetite has soared with U.S. equity markets erasing all of their losses for the year and breaking above significant resistance levels. However, we are starting to see some dollar support as the dismal U.K. GDP figures has taken the wind out of bull's sails for the moment. We won't have a robust earnings calendar as we have had the past few days but Microsoft's after the bell reported a 29% drop in profit from a year ago which could weigh on sentiment today. Strong growth in South Korea and more signs that the Euro-Zone economy is rebounding had erased concerns over the tech giant's earnings overnight but the weak U.K. figures could reignite concerns. Nevertheless, U.S. futures remain positive and continued strength today could lead to currency's finally breaking from their current ranges. However, we saw yesterday that the correlation between currencies and equities start to break down which should be watched today. Meanwhile, the University of Michigan consumer confidence final reading for July is due and expected to be revised higher to 65.0 from 64.6 but still lower from June's 70.8. A decline in optimism could limit expectations for domestic growth and add support for the greenback.

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To discuss this report contact John Rivera, Currency Analyst: jrivera@fxcm.com