British Pound Bounces Back as BoE Sees Risks For Inflation, Euro Extends Previous Day’s Decline

Talking Points
•    Japanese Yen: Rallies Across the Board
•    Pound: BoE Votes 7-1, Andrew Sentance Dissents
•    Euro: ECB Financing Increases
•    U.S. Dollar: Chairman Bernanke Testimony on Tap

The BoE policy meeting minutes showed the MPC voted 7-1 to maintain its current policy in July, with board member Andrew Sentance dissenting against the major for the second month and pushing for a 25bp rate hike, and the central bank may look to switch gears over the coming months as they expect the rise in the value-added-tax (VAT) to stimulate inflation over the following year.

At the same time, the MPC said that the outlook for future growth had “deteriorated a little,” with the board reviewing “arguments in favour of a modest easing in the stance of monetary policy,” and the central bank went onto say that “the softening in the medium-term outlook for GDP growth over recent months would put further downwards pressure on inflation, once the impact of temporary factors had waned.” As a result, the BoE concluded “it seemed likely that growth would be weaker than previously expected but, at least for a while, inflation was likely to be higher,” and the stickiness in inflation could give the central bank scope to raise the interest rate next year as price growth continues to hold above the government’s 3% limit. However, BoE board member Adam Posen said that there’s more than a 50% chance the MPC will move “to loosen rather than to tighten” according to an interview with the Dow Jones Newswires, and continued to see a risk for a double-dip recession as the economy struggles to brush off the recession.

The Euro extended the decline from the previous day and slipped to a low of 1.2791 during the overnight trade, and the uncertainties surrounding the results of the commercial bank stress test could push the exchange rate lower going into the U.S. trade as investors hold a cautious outlook for the region. A report by the Bank of Portugal showed commercial bank funding by the European Central Bank increased 12% in June to EUR 40.2B from EUR 35.8B in the previous month, while the nation’s Finance Ministry announced tax revenues increased 6% during the first-half of the year, which encourages an improved outlook for the region as the government struggles to balance its public finances. However, as the European financial system remains weak, with government officials taking steps to tighten fiscal policy, the ECB is likely to support the economy throughout the second-half of 2010 as it aims to encourage a sustainable recovery.

The greenback rallies against most of the majors, while the USD/JPY slipped to a low of 86.86 as the Japanese Yen rallied across the board, and the dollar could face increased volatility later today as Fed Chairman Ben Bernanke is scheduled to deliver the semi-annual monetary policy report to the Senate Banking Committee at 18:00 GMT. The central bank head is likely to maintain a dovish outlook for future policy as households continue to face tightening credit conditions paired with the deterioration in the labor market, and the chairman may reiterate his pledge to hold the benchmark interest rate close to zero for an “extended period” of time in an effort to stem the downside risks for the world’s largest economy.

How Will The European Bank Stress Test Affect The Exchange Rate? Join us in the Forum

Related Articles: 

Forex Trading Strategy Analysis: Trade with Market Conditions

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