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British Pound, Euro Strengthen On Renewed Risk Appetite, Will Bernanke Signal Rate Cut?

Monday, 20 October 2008 10:01:15 GMT  |  John Rivera, Currency Analyst

The British Pound rose above 1.7500 for the first time since October 15 on the back of increasing risk appetite.  The first weekend without major global systemic news and evidence that recent efforts are making an impact have started to restore risk appetite.

Talking Points
• Japanese Yen: USDJPY Above 102.00 On Risk Appetite
• Pound: Breaks Above 1.7500 On Strong Equities
• Euro: Inflation Data Cast Doubt On Rate Cut
• US Dollar: Bernanke To Speak Today

British Pound, Euro Strengthen On Renewed Risk Appetite, Will Bernanke Signal Rate Cut?

The British Pound rose above 1.7500 for the first time since October 15 on the back of increasing risk appetite. The first weekend without major global systemic news and evidence that recent efforts are making an impact have started to restore risk appetite. Although the announcement of the $10 billion dollar lifeline that the Netherland’s government gave to bank ING would have been news worth, but relative to the headlines from the past month, it was just viewed as some final housekeeping. Meanwhile, the Sterling shrugged off a report showing the U.K.’s budget deficit increasing to 8.1 million pounds - the highest on record.

The Pound Sterling may see a week of significant volatility as the calendar has a slew of event risk with the BoE minutes, retail sales and 3Q GDP due to cross the wires. The minutes from the central bank’s last rate reduction which led a coordinated rate cut from the major economies will give insight to the level of concern at the time and the possibility of future easing. The Credit Suisse overnight index swaps are still pricing in 139 bps of rate cuts as the U.K.’s economy is spiraling towards a recession. Indeed, retail sales are expected to have fallen 0.6% and growth contracted 0.2% as the country is already contracting. Therefore, we could se the pound trading heavy as we go through the week.

The Euro has started to give back earlier gains after reaching as high as 1.3533 on the back of higher than expected inflation data. German producer prices unexpectedly rose 0.3% in September bringing the annualized rate to 8.3% from 8.1%. The accelerating price pressures cast some doubt on another ECB rate cut as the central bank has continued to re-affirm its price stability focus. The majority of the gain was due to rising utility costs which are reflecting the impact of oil’s recent record setting run. Easing crude prices since then will continue to filter through the economy and will lead to easing inflation which should allow the central bank to follow the U.S. in continued easing. Despite the data, credit Suisse overnight index swaps are pricing in a 146 bps worth of cuts, which is the highest since the current crisis began.

The major event risk for the U.S. session will come from Chairman Ben Bernanke’s testimony to the house budget committee on the state of the economy. Traders will be looking for clues as to whether the FOMC will continue easing as expected and to the degree of a possible rate cut. Fed funds futures are pricing in a 62% chance of a 25 bps rate cut and a 38% possibility of a 50 bps cut. The chances of the deeper reduction have fallen from 46% just a day ago as fears start to ease. The economic calendar will provide little meaningful news with only the leading indicator gauge on tap and expected to show the economy will weaken going forward. The anticipated 0.2% decline will not shock traders as the current crisis should weigh on the economy for the foreseeable future. Risk winds may ultimately determine the dollar’s fate today, as a lack of headline news could lead to a return of risk appetite. Traders seeking riskier assets will sell recent acquired positions in U.S. treasuries which could weigh on the dollar today.

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U.K. Public Finances Surge Higher, Increased Borrowing to Continue

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