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Pound Direction to Be Determined by Risk Trends, As BoE far From Change in Monetary Policy

Pound Direction to Be Determined by Risk Trends, As BoE far From Change in Monetary Policy

2010-03-17 19:14:00
John Rivera, Currency Analyst
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GBP/USD

The Pound soared over 160 pips following a better than expected labor report which showed jobless claims fell 36,000 against exceptions for a gain of 6,000. The employment data combined with a non-eventful BoE minutes release allowed sterling bulls to build upon recent gains. The central bank had previously scared markets with talk of potentially adding to their asset purchase program. Although, policy makers haven’t ruled out such a move, there wasn’t any indication of an immediate threat. Improving fundamentals have decreased the likelihood of additional QE which has diminished the impact on price action from interest rate expectations. Indeed, the correlation between the two has weakened to 16% from 26% a week ago. Risk trends have started to re-establish its dominance as a driver of price action as yield expectations fade in importance, rising to 40% from 33% last week. Therefore, traders should take their cue from equity markets unless a change in monetary policy appears likely.

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GBP Interest Rate Expectations

Overnight index swaps are now pricing in 44 bps of rate hikes over the next twelve months from the BoE with expectations slightly higher than their low of 32.3 on February 25th. The central bank is talking QE which puts them well behind several of their counterparts on the path toward tightening. Although the U.K. is experiencing one of the highest levels of inflation of the developed economies, policy makers are forecasting that slack in the economy will ultimately drag prices lower, allowing them to take a measured approach. The upcoming mortgage approvals report is the next event risk that could potentially impact yield expectations as last month’s disappointing print sunk them. Tighter credit markets may force the MPC to add to their asset purchase program as they look to prevent a double dip recession. If this were the case then we could see a pull back in the sterling. To discuss this and trading ideas join the GBP/USD forum.

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FOMC Interest Rate Expectations

The FOMC left their benchmark rate unchanged yesterday while keeping the language, that rates will remain low for an “extended period”. Kansas City President Thomas Hoeing reiterates his objection and warned of creating asset bubbles. Despite the one objection, it appears the central bank will remain on hold into the second half of the year. However, the economic assessment from policy makers was a bit more upbeat as they touted increased business spending and a stabilizing labor market. It may not take a rate hike form the Fed to spark a longer-term dollar rally, as the mere removal of the “extended period’ language should suffice to sharply raise yield expectations.

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Risk

The Dow appears to be breaking from its recent wedge formation and in the process set a new 17 month high. The prospect of a low interest rate environment for the remainder of the year has raised the outlook for corporate profits. Markets may realize that the central bank is leaving rates on hold as they don’t see the economy growing fast enough to push inflation to threatening levels, which makes it susceptible to a sharp reversal. Until then the trend is higher which could signal further GBP/USD gains. Discuss this and other fundamental data join the Economics Forum.

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To discuss this report or be added to the email list contact John Rivera, Currency Analyst: instructor@dailyfx.com

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