Euro Bounces Back, British Pound Breaks Out on BoE Comments

Talking Points
•    Japanese Yen: Losing Ground Across the Board
•    Pound: Manufacturing Unexpectedly Holds Flat
•    Euro: Geman GDP Contracts 5.0% in 2009
•    US Dollar: Fed’s Beige Book, Monthly Budget Statement on Tap

Euro Bounces Back, British Pound Breaks Out on BoE Comments

The Euro pared the previous day’s decline against the greenback and rose to a high of 1.4555 during the overnight trade, and the single-currency is likely to hold a narrow range over the next 24 hours of trading as the European Central Bank is scheduled to announce its interest rate decision on Thursday at 12:45 GMT. The ECB is widely anticipated to keep the benchmark interest rate at 1.00% as the Governing Council aims to balance the risks for the economy, and the central bank may hold a dovish outlook for future policy as the board anticipates price pressures to remain subdued throughout the first-half of 2010.

Meanwhile, Greek Finance Minister George Papaconstantinou said that the nation is on track to resolve its problems and went onto say that it would not need a bailout according to Germany’s Handelsblatt newspaper. Nevertheless, a report by the Federal Statistics Office showed economic activity in Germany contracted at an annual pace of 5.0% in 2009 after advancing 1.3% in the previous year, which exceeded expectations for a 4.8% drop in GDP, while the budget deficit swelled to 3.2% of GDP during the year after holding flat in 2008. As the expansion in monetary and fiscal policy continues to feed through the real economy, the Bundesbank forecasts GDP to grow 1.6% this year and 1.2% in 2011 however, fears of a protracted recovery may lead the ECB to maintain a dovish policy stance this year as price pressures remain subdued.

The British Pound extended the rally from earlier this week and broke out of its recent range to reach a high of 1.6283 against the U.S. dollar, and the currency may continue to retrace the decline from the December as market participants speculate the Bank of England to normalize policy this year. BoE Board Member Andrew Sentence said that the central bank should halt its GBP 200B plan and assess the risks for inflation as policy makers anticipate price pressures to exceed the 2% target in the short-run during an interview with the Guardian newspaper. Mr. Sentence stated that the central bank could adopt a ‘wait and see’ approach as the “recovery gathers momentum,” and went onto say that the “early phase” of the recovery could feel “fragile and uncertain” as the global financial system remains impaired. Nevertheless, industrial outputs in the U.K. increased 0.4% in November to top forecasts for a 0.3% rise, while the annualized rate slipped 6.0% from the previous year after tumbling 8.4% in the previous month. At the same time, manufacturing unexpectedly held flat for the second, with the annualized rate falling 5.4% from the previous year amid expectations for a 5.1% decline, and the data reinforces a weakened outlook for future growth as businesses keep a lid on production and employment.

The greenback weakened against most of its major counterparts, but halted the three-day decline against the Japanese Yen to reach a high of 91.50, and the reserve currency is likely to face increased volatility throughout the North American trade as the Federal Reserve is scheduled to release its Beige Book economic report at 19:00 GMT. At the same time, the monthly budget statement is expected to show a shortfall of $92.0B in December from $51.8B in the previous month, and the data could drag on the exchange rate as investors weigh the prospects for a sustainable recovery in the world’s largest economy. Nevertheless, as risk trends continue to dictate price action in the foreign exchange market, a rise in risk appetite could drive the U.S. dollar lower as it remains the most popular funding-currency next to the Japanese Yen.

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To discuss this report contact David Song, DailyFx Research: dsong@fxcm.com