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• British Pound Down Nearly 2% After UK GDP Surprisingly Shows Economy is Still Contracting

•    US Dollar Bounces on Stock Market Declines, Jump in NAR Existing Home Sales
•    Euro Rallies as German Business Confidence Improves, PMI Composite Hits Nearly 2-Year High
•    Australian Dollar Follows DJIA, S&P 500 Down from 2009 Highs as Risk Appetite Fades

British Pound Down Nearly 2% After UK GDP Surprisingly Shows Economy is Still Contracting
By Friday’s close, the British pound fell more than 1 percent against the Japanese yen and nearly 2 percent versus the US dollar and euro after the release of a deeply disappointing Q3 report. Contrary to expectations, the UK did not emerge from recession, and instead, the economy contracted for the sixth straight quarter, this time by -0.4 percent. Though this is marginally better than the reading of -0.6 percent we saw in Q2, the index missed forecasts for a 0.2 percent increase. Likewise, the annual rate of growth edged up to -5.2 percent from -5.5 percent, but fell short of expectations for a move to -4.6 percent. A breakdown of the report shows that nearly every UK business sector remained in recession, as the services industry component fell by 0.2 percent while the production industry component tumbled 0.7 percent. The release of GDP led to a sharp reaction from the British pound as Credit Suisse overnight index swaps shifted to price in a 10 percent chance of a 25 basis point cut by the BOE during their next meeting, while expectations for rate increases over the next 12 months have fallen to 88.1 basis points from 93.4 basis points.  

All told, the news will put much more pressure on the BOE when they meet again in November. In the minutes from the central bank’s last policy meeting, we learned that their quantitative easing (QE) program would take another month to complete. We also learned that the "forecast round ahead of the November Inflation Report would provide an opportunity to assess more fully how the medium-term outlook for activity and inflation had evolved since August," and if the latest economic data has any bearing on the MPC’s bias, they may have the justification to expand their target level of asset purchases.

US Dollar Bounces on Stock Market Declines, Jump in NAR Existing Home Sales
The US dollar - which remains inversely correlated with the S&P 500 - was easily the strongest of the majors on Friday as the DJIA and S&P 500 backed down from their 2009 highs. Meanwhile, the National Association of Realtors (NAR) reported that US existing home sales surged 9.4 percent in September to an annual rate of 5.57 million, which is the highest since July 2007, as the federal government’s first-time homebuyer tax credit remains supportive of the sector. The rise in demand has helped to drive supply levels down to 7.8 months from 9.3 months, but it has not done the same for prices. If anything, sellers are still baiting buyers with lower prices, as median values slipped to $174,900 from $177,300, which represents an 8.5 percent drop from a year ago. 

Looking ahead to next week, On Tuesday, the October reading of the Conference Board’s measure of US consumer confidence is expected to edge up to a reading of 53.5 from 53.1, but overall, there are some downside risks for this report. Indeed, the preliminary reading of the University of Michigan’s consumer confidence index show that sentiment deteriorated more than anticipated in October, with the index falling to 69.4 from 73.5. A breakdown showed that as the “economic conditions” component slipped to 72.1 from 73.4, while the “economic outlook” dropped to 67.6 from 73.5. Overall, disappointing numbers could have especially negative repercussions for risk appetite, but if the index rises in line with expectations or proves to be surprisingly strong, FX carry trades could gain and weigh on the US dollar.

Euro Rallies as German Business Confidence Improves, PMI Composite Hits Nearly 2-Year High
The euro may have fallen against the greenback, but the currency rallied versus the rest of the majors, particularly against the British pound. European data was surprisingly strong and indicated that the region may have one of the strongest economies around. According to the IFO survey, German business confidence rose to a 13-month high of 91.9 in October from 91.3, adding to indications that growth is improving in Europe’s largest economy. The news comes a week after the German government raised forecasts for GDP, as they predict the economy will grow by 1.2 percent in 2010 after contracting 5 percent in 2009. Furthermore, the purchasing managers' index (PMI) for the manufacturing sector rose above 50 in October - signaling an expansion in activity - for the first time since May 2008. Meanwhile, PMI for the services sector signaled expansion for the second straight month by rising to match the February 2008 high of 52.3 from 50.9. Ultimately, this pushed composite PMI up to a nearly 2-year high of 53.0 from 51.1, suggesting the Euro-zone is closer to recovery than many other places.

Australian Dollar Follows DJIA, S&P 500 Down from 2009 Highs as Risk Appetite Fades
The Australian dollar was one of the weakest majors on Friday as broad US dollar strength and declines in equities weighed on the carry trade currency. The Aussie will face high event risk next Tuesday, when data is forecasted to show that Australia's headline consumer price index rose 0.9 percent during Q3, bringing the annual rate down to a 10-year low of 1.2 percent from 1.5 percent. However, the Reserve Bank of Australia’s core measures are projected to hold at more robust levels on an annual basis, with the trimmed mean anticipated to slip to 3.2 percent from 3.6 percent and the weighted median forecasted to slip to 3.7 percent from 4.2 percent. Such moves would tell us that prices for volatile items like energy are responsible for the steep drop in headline consumer prices, and unless the core measures plunge, the markets are likely to remain in favor of additional rate hikes by the Reserve Bank of Australia. In fact, Credit Suisse overnight index swaps are full pricing in a 25 basis point increase by the RBA during their next meeting on November 2, and stronger-than-expected consumer prices could further this sentiment and send the Australian dollar higher.

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Written by: Terri Belkas, Currency Strategist for DailyFX.com
E-mail: tbelkas@dailyfx.com
 

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