British Pound Breaks Through 1.5800, Euro Pares Friday’s Decline To Hold Above 1.3000

Talking Points

• Japanese Yen: Loses Ground Against The Majors
• Pound: PMI Manufacturing Weakens, But Tops Forecast
• Euro: Manufacturing Expands At Faster Pace in July
• U.S. Dollar: ISM Manufacturing, Fed Chairman Bernanke on Tap

The BoE is widely expected to hold the benchmark interest rate at 0.50% and maintain its asset purchase target at GBP 200B later this week as the new coalition in the U.K. targets the budget deficit and tightens fiscal policy, but we are likely to see MPC board member Andrew Sentance dissent against the majority for the third time as price growth holds above the government’s 3% limit.

As the economic outlook remains clouded with uncertainties, BoE Governor Mervyn King is likely to hold a neutral policy stance over the coming months in order to balance the risks for growth and inflation, but the split amongst the board members could lead the sterling to trend higher over the near-term as they forecast inflation to hold above the 2% going into 2011. However, the central bank may refrain from releasing a policy statement like we’ve seen during the past few months, and the British Pound could show a muted reaction to the interest rate decision as the MPC is scheduled to release the meeting minutes on August 18 at 8:30 GMT. Nevertheless, the economic docket showed manufacturing activity in Britain expanded at a slower pace in July, with the PMI reading falling back to 57.3 from a revised 57.6 in the previous month, which was still higher than forecasts for a 57.0 clip, and the recovery may gather pace going into the end of the year as the central bank continues to support the real economy.

The Euro pared Friday’s decline and bounced back during the overnight trade to reach a high of 1.3088, and the rebound in market sentiment may continue to drive the exchange rate higher over the near-term as the 20-Day SMA (1.2853) crosses above the 100-Day SMA at 1.2840. Meanwhile, Chairman of the Basel Committee on Banking Supervision Nout Wellink said that the new capital and liquidity rules under the Basel III is “substantial” and expects the regulations to take effect before 2018, and went onto say some commercial banks may need to additional steps to raise capital according to an article in a morning newspaper in the Netherlands. Nevertheless, market participants speculate the European Central Bank to hold the key interest rate at 1.00% later this week as the financial system remains weak, and comments from President Jean-Claude Trichet at the press conference following the rate decision is likely to stoke increased volatility in the exchange rate as investors weigh the prospects for future policy. Meanwhile, the final July manufacturing PMI reading for the Euro-Zone was revised to 56.7 from an initial forecast of 56.5, but the tightening in fiscal policy could drag on the recovery over the coming months as the governments operating under the fixed-exchange rate system struggle to manage their public finances.

The greenback weakened against most of its major counterparts following the shift in market sentiment, and the dollar may continue to lose ground going into the North American trade as equity futures foreshadow a higher open for the U.S. market. Nevertheless, manufacturing activity in the world’s largest economy is expected to expand at a slower pace in July, with market participants forecasting the ISM index to weaken to 54.0 from 56.2 in the previous month, while Fed Chairman Ben Bernanke is scheduled to speak about the economy in Charleston, South Carolina at 14:15 GMT.

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

mailto:dsong@fxcm.com