Pound Higher On Increased Optimism Despite CPI Below BoE Target, Earnings and Retail Sales Ahead For Dollar

Talking Points
•    Japanese Yen: Under Pressure On Increased Risk Appetite
•    Pound: Inflation Falls Below BoE’s 2% Target
•    Euro: German ZEW Falls For First Time in Nine Months
•    US Dollar: Retail Sales On Tap

Pound Higher On Increased Optimism Despite CPI Below BoE Target, Earnings and Retail Sales Ahead For Dollar

The pound continued to rally despite inflation falling below the BoE’s 2% target for the first time since September 2007. The June consumer price index dropped to 1.8% from 2.2% which was the consensus from economists and inline with the central bank’s prediction that it would fall and remain below the target rate for the remainder of 2009. Rallying equity markets and bullish comments from MPC member Andre Posen helped send the GBP/USD over 1.6300.

The fall in inflation was due to declines in several key categories including food, housing and clothing which led all sectors with a 1.4% decline. The decline in prices may force the central bank to add to their quantitative easing efforts at their next policy meeting in August which could begin to weigh on sterling as we approach decision time. Indeed, Andrew Posen would caution that short-term risks remain higher for deflation over inflation. He would go on to say that a deflationary situation is very difficult to emerge from and should generate greater concern. However, he did offer an optimistic outlook on growth stating that he was reasonably confident that the downturn will be overcome and would be surprised not to have positive growth by 2010. We saw the GBP/USD bounce from support at the 50-Day SMA at 1.6055 yesterday as the pair continues to remain range bound. Therefore, a test of the 20-Day SMA today at 1.6357 could lead to a reversal.

The Euro saw earlier gains generated on the back on the prevailing risk appetite reversed on a disappointing German Zew reading which declined for the first time in nine months. Investor confidence fell to 39.5 from 44.8 as concerns over the scope of a recovery has started to dim the outlook for growth. The reading significantly missed expectations of 47.8 which could be a sign that the recovery is stalling. However, Euro-Zone industrial production gained for the first time in nine months in May by 0.5% led by the 1.2% improvement ion capital goods. The increased investment is a strong sign of future growth and that the economy is at least stabilizing. The EURUSD has been anchored by the 20-Day SMA at 1.3982 which may be a precursor to a breakout. If demand for risky assets continues today then we could see Euro support return and a test of 1.4075-the 7/9 high. However, be aware of the downside risks and a break below the 50-Day SMA 1.3905 could lead to extended losses.

The dollar has continued to be under pressure during overnight trading as demand for risky assets has carried over through Asia and Europe after yesterday’s surprising rally in U.S. markets. An analyst upgrade of Goldman Sachs helped spur optimism that earnings may be better than expected especially for the beleaguered banking system. If we see the investment bank show signs of sustainable earings in its quarterly report , then continued support for equities may weigh on the greenback. U.S. advance retail sales for June will cross the wires before the market open and is expected to show a 0.4% increase following last month’s 0.5% gain. An increase in consumer consumption will only fuel existing risk appetite and add more pressure to the greenback. However, if we see signs of weakness in domestic growth and other earnings reports such as Johnson & Johnson show that that consumers are continuing to retrench, then the outlook for earnings could dim as it had been leading into the week. Additionally, al of the Goldman Sachs news may already be priced in to the market leading to a reversal despite the results. Also, PPI figures could add to bullish sentiment if we see an increase in pricing power.

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Forex Trading Weekly Forecast - 07.13.09

To discuss this report contact John Rivera Currency Analyst: jrivera@fxcm.com