Pound strengthens after service activity accelerates

Just when the story was starting to make sense, everything suddenly changed. That's how the markets feel this morning as the dollar fights back, the price of gold is in decline and tepid data from around the world detracts from the story of recent days that risk-aversion is back in town. The dollar gained against the euro as it strengthened to $1.4536 despite a decline in both initial and continuing jobless claims in a sign that the labor market is getting marginally better. Elsewhere several central banks in Asia, Europe and north America left interest rates unchanged helping to fuel a rally in bond prices.

The pound was a strong performer Thursday after the Bank of England left interest rates unchanged at 0.5%. No change was expected and the Bank confirmed its asset purchase plans. Earlier this week the NIESR said it believes the recession possibly ended in May. Although the Bank is concerned that the banking system is not passing on loans to customers as readily as it would like, investors continue to pick out the positive aspects and once again are willing to buy into a rising pound sterling.

The Halifax division of Lloyds Banking Group surveyed service companies to reveal the fastest pace of expansion in two years, while London's FTSE stock index reached an 11-month high as investors bought into the rising tide of risk appetite. The pound added to earlier in the week gains and stands at $1.6634 against the dollar and flexed its muscles against the euro, which today buys slightly less pennies at an exchange rate of 87.34.

The New Zealanders and the Canadians also left interest rates unchanged. The Bank of Canada also reiterated that it expects to keep rates on hold through the second quarter of 2010.

A series of U.S. bond and note auctions culminates with a $12 billion offering of 30-year bonds this afternoon. That will lift the weekly total to $70 billion, and so far fixed income appetite from investors has been sufficiently strong to put a bid under the market. With relative strength in the world's equity markets and record low cash rates at the front end of the curve it's becoming quite the perfect scenario for investors. Some are pointing to the resurgence of merger and takeover activity as a sign that health is returning to that part of the market. The availability of bank funding for corporate deal flow will surely be taken as a sign that banks are once again lending.

Supported by unchanged announcements from central banks today and successful U.S. auctions this week, interest rate futures have started to rally and so are predicting a smaller amount of monetary tightening going forward. In the U.S. as the yield curve declines it is also flattening too.

In Australia the odds of an October rate rise were slashed in half overnight from one-in-four to just one-in-eight following the employment report, which showed a large rise in full-time job losses. The overall report showed that 27,100 jobs were shed in August after the creation of 33,600 in July. Losses of 15,000 were predicted by economists.

The dour news sent the Aussie scurrying lower against the dollar and it currently stands at 85.95 U.S. cents, sown on the day but a good half penny above its intraday low. While some had bought the Aussie dollar in the expectation that the Reserve Bank may start to raise short-term cash rates as early as next month evidence this week has argued for no change. A string of nine back-to-back readings of increasing home loan approvals came to an end this week, while retail sales data also declined for the second month in a row. While this may give the appearance of a premature reversion to a 12-month high for the Aussie unit, one has to remember that thanks to its commodity-driven demand, the Australian dollar has benefited from rising risk appetite stemming from Asia.

Against the Canadian dollar and the Swiss franc the U.S. dollar is slightly improved. The dollar buys C$1.0823 cents and Sfr1.0405 today. Meanwhile as the stock market struggles to find direction today the yen is beating at the dollar's door today and has strengthened to a new high for the current move. Earlier we track a yen price at ¥91.43 while the dollar recently traded at ¥91.78.

Andrew Wilkinson

Senior Market Analyst ibanalyst@interactivebrokers.com