British Pound Halts Two-Day Rally Despite Drop in Unemployment, Euro Extends Decline on Risk Aversion

Talking Points
•    Japanese Yen: Benefitting From the Rise in Risk Aversion
•    Pound: BoE Votes Unanimously to Maintain Current Policy
•    Euro: German Producer Prices Unexpectedly Fall in December
•    US Dollar: Producer Prices, Housing Starts on Tap

British Pound Halts Two-Day Rally Despite Drop in Unemployment, Euro Extends Decline on Risk Aversion

The British Pound halted its two-day rally against the greenback following a rise in risk aversion and slipped back below the 100-Day SMA (1.6312) to reach a low of 1.6252 during the overnight trade. Meanwhile, the Bank of England policy meeting minutes showed the MPC voted unanimously to keep the benchmark interest rate at the record-low of 0.50% and maintain its GBP 200B asset purchase program in order to encourage a sustainable recovery, and expects inflation to rise “well above the 2 percent target in the early part of 2010 and remain elevated for several months.”

As a result, the BoE argued that inflation expectations may “drift upwards” over the coming months as price pressures intensify, but went onto say that price growth will “fall below the target for a period once the various near-term price-level shocks to inflation had worked through.” In addition, the central bank noted that the economy continues to face “powerful headwinds” as households face fading demands for employment paired with tightening credit standards, and warned that “a significant fiscal consolidation was needed in the United Kingdom” as the MPC aims to normalize policy this year. Nevertheless, jobless claims in the U.K. contracted15.2K in December after falling a revised 10.8K in the previous month, which exceeded expectations for a 4.6K drop, while the claimant count rate held steady at 5.0% for the fourth consecutive month. At the same time, the ILO jobless rate unexpectedly slipped to 7.8% during the three-months through November from 7.9% in the month prior, and conditions are likely to improve going forward as the expansion in monetary and fiscal policy continues to feed through the real economy.

The Euro extended the decline from earlier this week and slipped back below the 200-Day SMA (1.4293) to reach a fresh monthly low of 1.4166, and the single-currency may continue to trend lower over the remainder of the month as policy makers hold a cautious outlook for the economy. European Central Bank board member Ewald Nowotny said growth “in central and eastern Europe may be slower than in the western part,” and argued that there “are some specific problems, specific to the Eastern region” during a conference in Vienna, Austria. At the same time, Governing Council Member Juergen Stark noted that economic activity during the first-half of 2010 could be weaker than the second-half of the previous year as the central bank continues to see a risk for a protracted recovery, and said that the economic outlook remains highly uncertain as the global financial system remains impaired. Meanwhile, the economic docket showed producer prices in Germany slipped 0.1% in December amid forecasts for a 0.2% rise, while the annualized rate slipped 5.2% from the previous year after contracting 5.9% in the previous month. As a result, the ECB is widely expected to hold the benchmark interest rate at 1.00% at the February 4 meeting, and is likely to maintain a dovish outlook for future policy as the central bank expects price pressures to remain subdued throughout the year.

The greenback has certainly benefitted from the rise in risk aversion, while the USD/JPY retracted the previous day’s advance to reach a low of 90.78, and the dollar may continue to strengthen going into the North American trade as equity futures foreshadow a lower open for the U.S. market. At the same time, producer prices in the world’s largest economy is projected to hold flat in December after rising 1.8% in the previous month, while the annualized rate is expected to increase 4.5% during the month, which would be the highest reading since October 2008. In addition, housing starts are forecasts to weaken to an annual pace of 572K from 574K in November, while building permits are anticipated to fall to 580K from 584K, and the data could spark increased volatility in the U.S. dollar as investors weigh the prospects for a sustainable recovery.

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