British Pound Firms Despite Bearish Inflation Report and Unemployment Reaching 14 Year High

Talking Points
•    Japanese Yen: Starting To Give Back Post BoJ Gains
•    Pound: Unemployment Reaches 14 Year High
•    Euro: Industrial Production Unexpectedly Falls
•    US Dollar: FOMC Rate Decision on Tap

British Pound Firms Despite Bearish Inflation Report and Unemployment Reaching 14 Year High

The pound fell to 1.6390 but started to find technical support ahead of the release of U.K. jobless claims and the BoE quarterly report. Sterling was weighed when the MPC stated that inflation will remain below their 2% target over the medium term amid a slow recovery. The central bank cited this as justification for the additional £50 billion in asset purchases that was announced last week. Meanwhile, the economy lost 24,900 jobs in July which brought the claimant count rate to 4.9%-the highest in 14 years. However, it missed expectations of 28,000 and saw the prior month’s loss revised lower to 21,500 from 23,800 which helped provide sterling support before the inflation assessment was released.

BoE Governor Mervyn King stated that the additional quantitative easing will help return inflation to the MPC’s 2% target which is necessary for an economic recovery. However, he would go onto say that without an increase in bank lending, the scope of the recovery would be limited. The central bank leader also forecasted that unemployment would continue to rise as the economy is in a deep recession. The subdued report was expected by markets which limited the bearish reaction to the comments. Additionally, Governor King pointing to encouraging signs of improvement raised expectations that the central bank’s efforts to boost liquidity may be coming to an end. The 50-Day SMA continues to provide staunch support for the pair at 1.6432 and may limit downside risks.

The euro has started to regain its footing after falling to an intra-day low of 1.4086 despite an unexpected drop in Euro-Zone industrial production. Output in the region dropped by 0.6% in June which missed expectations of a 0.3% gain, led by a 4.2% decline in durable goods orders. The decline in long lasting items could be a sign that growth may be difficult to obtain going forward as businesses sand consumers continue to remain cautious despite signs that the recession is easing. The ERUUSD is testing the 50-Day SMA at 1.6432 which is a critical support level that has held since March. A break below exposes the pair to considerable downside risks with a possible test of the 100-Day SMA at 1.5770.

The dollar had been firming as risk aversion crept back into the marketplace but we are starting to see it give back its gains. Although, we aren’t see as strong a correlation to risk sentiment as the Yen, it is clear that we haven’t completely shifted to a new paradigm where the greenback is trading solely on fundamentals, as it did following the strong US employment report. Therefore, today’s FOMC rate decision may present a win-win situation for the dollar. A hawkish Fed will raise interest rate expectations and should provide dollar support, as markets are already starting to price in a rate hike by the end of the year. Although, we feel that that is an overly optimistic view, nevertheless those expectations will impact price action. Also, dollar support could also been found from the FOMC announcing an end to their quantitative easing program which would precede any raise in interest rates Conversely, dovish comments from the central bank could feed into prevailing concerns that downside risks to growth remain beyond government stimulus and inventory build ups and refuel the safe haven trade. However, recent greenback support has been founded on the rising interest rate expectations and a bearish outlook from policy makers could lead to an unwinding of those positions and dollar weakness.

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