British Pound Rallies BoE Minutes, Euro Steady Ahead of FOMC Rate Decision

Talking Points
•    Japanese Yen: Higher Against Most Currencies
•    Pound: BoE Voted 7-1 to Maintain Current Policy
•    Euro: Manufacturing, Services Expand at Slower Pace in June
•    U.S. Dollar: New Home Sales, FOMC Interest Rate Decision on Tap

The BoE policy meeting minutes showed the central bank voted 7-1 to hold borrowing costs at 0.50%, with Mr. Sentance opting for a 25bp rate hike as price growth remains above the 3% limit for inflation, and the stickiness in prices may lead to shift in the MPC’s economic assessment as it aims to balance the risks for the economy.

The minutes went onto say that “other members thought that changes to the balance of risk were insufficient to warrant a change in the stance” of monetary policy as Governor Mervyn King continues to see a substantial amount of slack within the real economy, and the BoE may continue to support the economy in the second-half of the year as the new government in the U.K. plans to cut public spending and tighten fiscal policy. However, the resilience in price growth could lead to an even bigger split going forward as the rebound in economic activity gathers pace, and members of the MPC may turn increasingly hawkish over the coming months as policy makers begin to discuss withdrawing monetary stimulus from the economy. Nevertheless, a report by the British Bankers’ Association showed loans for home purchases increased to a five-month high of 36,709 in May from 35.964 in the previous month, while the Confederation of British Industry’s gauge for retail spending advance to -5 in June after unexpectedly slipping to -18 in the month prior.

The Euro was little changed overnight, with the exchange rate continuing to hold above the 20-Day SMA at 1.2205, and the single-currency is likely to hold steady going into the U.S. session as the Federal Reserve is scheduled to announce its interest rate decision later today. Meanwhile, the monthly Statistical Bulletin by the Bank of Portugal showed European Central Bank funding for Portuguese commercial banks more than doubled in May, with the figure climbing to EUR 35.8B from EUR 17.7B in April, and the Governing Council may look to support the economy throughout the second-half of 2010 as the debt crisis continues to hamper the prospects for future growth. Moreover, manufacturing and service-based activity in the Euro-Zone expanded at a slower pace in June, with the composite index falling back to 56.0 from 56.4 in May versus expectations for a drop to 55.8, and businesses may keep a lid on production going forward as the outlook for future growth remains clouded with uncertainties.

The greenback weakened against most of its major counterparts, with the USD/JPY extending the previous day’s decline to reach a low of 90.17, and the dollar will certainly face increased volatility during the North American session as the Fed is scheduled to release its policy statement at 18:15 GMT. The FOMC is widely expected to hold the benchmark interest rate at 0.25% later today as Chairman Ben Bernanke pledges to hold borrowing costs near zero for an “extended period” of time, but a shift in the central bank’s rhetoric could drive the greenback higher as investors speculate the Fed to normalize monetary policy further in the latter half of the year. Meanwhile, new home sales in the world’s largest economy is expected to contract 18.7% in May and fall back to an annualized pace of 410K from 504K in April, and the ongoing weakness in the housing market could weigh on the outlook for future growth as slack within the private sector drags on overall growth.

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