Currency Update – Wednesday 7th July

Currency Update – Wednesday 7th July

In a relatively quiet day for data yesterday, currency markets sought direction from various sources, including the performance in global equity markets. The only events of note were the Reserve Bank of Australia's Base Rate decision and the ISM Non-Manufacturing Index release in the US, both of which proved influential to yesterday's movements. Latching on to upbeat comments from the Reserve Bank of Australia on the outlook for the domestic economy and, crucially, for growth in China and Latin America, a burst of confidence swept through markets generally, lifting equities and riskier currencies as investors retreated from their most dire fears about a double-dip global recession. Stock markets and industrial metals prices rose accordingly. On the domestic front, traders had priced a small chance of an official interest rate cut going into yesterday’s RBA Board meeting, with some looking for a dovish statement opening the door to a rate cut in coming months. As such, traders were short the AUD going into the RBA announcement. There was no change in the 4.5% cash rate, as expected. However, the RBA’s statement wasn’t dovish, which triggering a rally in the AUD as short-term interest rate expectations were consequently boosted. The RBA held the line on its global and domestic growth outlooks, seeing both at around trend, and still forecast that underlying inflation would be in the upper half of its target range over the next year. As such, there was no opening of the door to a future interest rate cut, and AUD/USD rebounded almost 3% from a low of 0.8317 to a high of 0.8560. Indeed, the AUD was the best performing G10 currency yesterday.

Meanwhile, concerns that the USA recovery is in danger of stalling, following Friday’s Non-Farm Payrolls release, mounted when the ISM report on service sector activity dropped further than expected. The Institute for Supply Management’s non-manufacturing index fell from 55.4 – the level at which it has stood since March – to 53.8, disappointing economists who were expecting a much smaller decline to 55. Any reading above 50 indicates an expansion of activity, and in this case, it was the sixth consecutive month that the ISM survey revealed growth in the services sector, which accounts for 78 per cent of US economic output. Nevertheless, the unexpectedly large decline will reinforce the view that the US economy entered a rough patch after the financial turmoil caused by the European sovereign debt crisis. This spurred the recovery in EUR/USD, which spiked by a cent in the aftermath to 1.2650, but has drifted back since to its current 1.2580 level. Improved risk appetite on the back of the RBA meeting, and strong equity performance provided general support for Sterling, pushing it through 1.52 against the USD, but has since dipped back as risk appetite dissipated somewhat.

Today is another quiet day for data, the only event of note being the revision for Q1 GDP in the Eurozone. Markets await tomorrow's rate meetings in the UK and Eurozone, with attention again tuned for more subtle clues from the accompanying statement and minutes release that follow.

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