British Pound Halts Four-Day Decline on Risk Appetite, Euro Continues to Hold Narrow Range

Talking Points
•    Japanese Yen: Loses Ground Against the Majors
•    Pound: BoE Sees Need For Regulator Overhaul
•    Euro: Manufacturing, Services PMI Tops Forecasts
•    US Dollar: Existing Home Sales, Chicago Fed Index on Tap

British Pound Halts Four-Day Decline on Risk Appetite, Euro Continues to Hold Narrow Range

The British Pound halted the four-day decline against the greenback after finding support ahead of the 100-Day SMA at 1.6400, and crossed back above the 20-Day SMA (1.6591) to reach a high of 1.6630 following the rebound in risk appetite. As a result, the GBP/USD may continue to retrace the sell-off from the previous week and trend higher over the remainder of the month as policy makers see the economy emerging from the worst recession since the post-war period however, we could see the pair hold a broad a broad range going into the end of the year as investors weigh the outlook for future policy.

The Bank of England said that “effective macro-prudential policy instruments are an important missing ingredient from the current policymaking toolkit” on its website over the weekend, and argued that the economic downturn “would have been less costly” if policy makers were able to “moderate exuberance in the supply of credit.” As a the financial system remains fragile, the Confederation of British Industries sees businesses lowering their reliance on bank lending and expects 50% of companies in the U.K. to curb bank funding as firms look to “take lower risks with their balance sheets for some time to come.” At the same time, International Monetary Fund Managing Director Dominique Strauss-Kahn argued that “public support will have to last some time more until recovery is firmly established,” but expects to see a “strong recover” in the following year as the government takes unprecedented steps to steer the nation out of recession. As the BoE maintains an “open mind” for future policy, the central bank may ease policy further over the coming months to encourage a sustainable recovery, and investors may continue to scale back long-term expectations for higher interest rates in the U.K. as the MPC sees a risk for a protracted recovery.

The Euro bounced back against the U.S. dollar after finding support ahead of the 50-Day SMA (1.4813) however, the lack of momentum to push above the monthly high at 1.5050 may keep the EUR/USD within a narrow range throughout the week as market participants weigh the outlook for future growth. Nevertheless, the bearish divergence in the RSI suggests that the November rally may have peaked ahead of the yearly at 1.5064, and we may see the double-top formation play out over the coming week as
Meanwhile, the economic docket showed manufacturing and service-based activity in the Euro-Zone expanded at a faster pace in November, with the PMI reading increasing to 51.0 and 53.2 from 50.7 and 52.6 respectively, while the composite index advanced to 53.7 from 53.0 to mark the highest reading since December 2007. At the same time, ECB member Miguel Angel Fernandez Ordonez held an improved outlook for the economy and expects inflation to turn positive over the coming months as the economy returns to growth, and went onto say that the markets anticipate to see higher interest rates in the second-half of 2010 as the central bank maintains its one and only mandate to ensure price stability.

The U.S. dollar weakened across the board as investors raised their appetite for risk, and the greenback may continue to face increased selling pressures going into the North American trade as the USD remains the most popular funding-currency next to the Japanese yen. Nevertheless, economists forecast existing home sales in the U.S. to increase 2.3% to an annualized pace of 5.70M in October after rising 9.4% previous month, which would be the highest level since July 2007, and the data is likely to reinforce an improved outlook for future growth as the economy emerges from the worst recession since the Great Depression. Meanwhile, the Chicago Fed National Activity index is scheduled to cross the wires at 13:30 GMT, and the data could spark increased volatility in the currency market as investors weigh the prospects for a sustainable recovery in the U.S.

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To discuss this report contact David Song, Currency Analyst: dsong@fxcm.com