YB Currency Update – Wednesday 17th June

YB Currency Update – Wednesday 17th June

It seems I spoke to soon yesterday when I wrote that the fears for the central role the Dollar plays in foreign currency reserves were starting to abate. That view was prompted by reassurances from Russia that the Dollar's place wouldn't be discussed at the first summit of the BRIC countries (Brazil, Russia, India, and China), however a conflicting message came out of Russia yesterday with the President himself saying that the current reserve currencies have not performed their function, and the finance minister said that the summit would contain talk over the USD's reserve currency role. This weakened the Dollar slightly, and coupled with a positive housing starts data, up 17.2%, helped the Pound climb to almost 1.65, however a weaker than expected industrial production survey limited some of the Dollar's weakness, and further showed the peculiar inverse relationship between the Dollar and domestic US economic data.

The Pound also rallied against the Euro, as the two central bank's policies, as well as the strength of their currencies, had their effect on inflation. The BoE have reacted to the credit crunch and economic downturn by cutting rates drastically, and implementing QE measures, an inflationary policy, while the weak Pound has also pushed up import prices. UK inflation came out at  2.2%, higher than expected, still above the 2% target, and although the BoE work on a 2 year horizon, so the short term fluctuations shouldn't effect immediate policy, the fact that inflation hasn't moderated as expected has raised the prospect that inflation may start to climb as we recover, with interest rates having to rise to combat this. Even though any such rise is far down the road, the markets have still reacted and the Pound has benefitted rising above 1.1850 yesterday, although it has moderated this morning.

The ECB have taken a slightly different approach to combating the recession, although they have cut rates quickly, it's not to the same extent as elsewhere, keeping rates to 1%, and not following any inflationary QE measures. With a tighter fiscal policy, and a stronger currency, It is therefore no surprise to see Eurozone CPI near 0%. The Euro is finding it hard to make any gains in spite of a better than expected ZEW survey out of Germany which came out at the highest for three years, and it has kept to a band around 1.39 against the Dollar.

Employment is a lagging indicator, which means that it didn't start to fall until we were already a good way into the slowdown, and it will continue to get worse even as the economy recovers. It is therefore little surprise that this morning's unemployment data was the worst for 12 years, with unemployment jumping above 2.25 million. We also get the BoE minutes later this morning, although these are unlikely to show anything but unanimous support for the continued policy.

Later today, there is CPI data for the US expected to tick higher gasoline prices rise. Sterling has taken a bit of a hit after the employment data, even though it was hardly a surprise, dropping near 1.63 against the Dollar, and back below 1.18 against the Euro.

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