Despite a lack of resolution regarding Eurozone aid to stricken peripheral countries, the euro rallied while other currencies turned more mixed performances against the greenback. Stocks and commodities pulled back somewhat from their recent records.
Another month, another upside surprise in British inflation numbers. The annual headline inflation number surged to 3.7% in December, much higher than consensus which was looking at an already sizable 3.4% YoY increase. Given that the VAT increase had not yet taken effect, it is likely the annual rate will soon be above 4.0%. The Bank of England seems so far unfazed, and Posen was on the wires dismissing the importance of the short-term inflation surprises and arguing that the economic slack will soon put downward pressure on the rate once the one-off factors driving the rate higher wear off. We tend to agree with him, though we have to admit that inflation has stayed higher for longer than we would have expected. Regardless, the apparent lack of concern on the part of monetary authorities minimized the impact of this release on Sterling, which mostly followed the euro higher against the dollar to end up 0.9% against the greenback but down the same amount against the common currency.
European authorities continued to indicate that they are moving towards a more comprehensive solution to the peripheral sovereign woes, though the lack of a centralized decision making process is still making markets nervous. However, it has become clear that Germany is dropping its opposition to expanding the role and perhaps also the size of the European rescue facility, the EFSF. Adding to the bullish euro mix was further macroeconomic strength out of the core European countries, and signs that the sizable short base that had developed in euro as traders used it late last year to fund emerging market carry trades. Therefore, it is not surprising that the scorching rally in the euro continued, rising another 1.9% against the USD to finish the week above 1.36.
Macroeconomic newsflow turned considerably more positive last week in the US, albeit mostly from second-tier reports. Weekly jobless claims dropped to 404,000 and housing permits (a leading indicator for the housing market) rose 16%, albeit from a dismal level. The relatively good news, together with the correction in commodities and stocks provided somewhat of a flight-to-safety bid to the greenback, which held up rather well in spite of the massive euro rally and lost just 0.3% in trade-weighted terms.
Last week saw a moderate weakening of the inverse correlation between the Japanese yen and US interest rates that had been by far the most critical driver of this currency over the last few weeks. The developing correction in asset markets kept the JPY higher than US yields would have predicted, until the severe back up in yields later in the weeks proved too much and forced the yen to give up much of its earlier gains, ending the week up just 0.3% against the USD.
The weakness in commodity prices spread to dollar bloc currencies last week. While the Australian dollar managed to end the week flat against the dollar, both the Canadian dollar and the New Zealand dollar were weighed down by moderately dovish domestic developments: a slightly more dovish than expected statement from the Bank of Canada, and soft quarterly inflation out of New Zealand that appears to put the RBNZ even further on hold. As a result, CAD lost nearly 0.5% and NZD over 1% against the greenback for the week.
The Scandinavian currencies reversed partly last week's moves in spite of the absence of critical news releases. Clearly, the relatively weak performance of oil weighed on the NOK, which ended down 1.2% against the EUR while the SEK lost only 0.5%
The Swiss franc’s sell-off against the euro continued last week, dropping another 1.3%, bringing relief to Swiss exporters. Swiss domestic demand and the real estate market is currently buoyant, and if this trend continues then the SNB will have to seriously rethink its zero-rate policy.