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investors focus on inflation data

The Martin Luther King Jr. Day holiday in America meant that trading volumes were thin on Monday. However, there was some movement, with sterling rising marginally versus the dollar to an eight-week high as well as climbing against the euro. This was mostly due to speculation over interest rate hikes in May. Overnight UK Nationwide consumer confidence and RICS came out above expectations, also helping to boost the sterling.

The markets are firmly focused on the pound ahead of today’s inflation data, which is expected to show that inflationary pressures are still weighing on the UK economy. Many investors feel that should we see CPI data for December continuing to rise above the 2% target, in tandem with increased prices, then the BoE will raise interest rates sooner than expected. For the pound this is a short term boost but potentially longer term issue as it signals a change in monetary policy direction for the BoE that could be costly during such an austere spending budget.

USD

Yesterday the greenback dropped off against the euro and the pound, reversing strong earlier gains as a US report showed housing starts were expected to decline in December. The underlying problems with a weak housing market in the US continued rumours that the Fed will keep interest rates on hold for a while yet. Elsewhere, headway could be being made in the 'currency wars' as Chinese president Hu Jintao arrived in the US today for bilateral talks. Currently, the US complains about China’s huge overall and bilateral trade surpluses, exchange rate peg, vast foreign currency reserves and violations of intellectual property rights. China complains about incompetent US financial regulation, vast fiscal deficits and the Federal Reserve’s quantitative easing. Yet the meeting may not be as inauspicious as it seems with both keen to address the currency issue as they look to secure their positions as the key players on the global recovery.

EUR

The single currency fell against the dollar yesterday as disagreement and conjecture continued among EU finance leaders over the size of the Eurozone safety fund (EFSF) and the Irish PM was mired in political turmoil as he faces a no confidence vote. The euro also slipped off against the pound after gains last week due to successful bond auctions in Portugal and Spain. Finance ministers met in Brussels on Monday to discuss potentially increasing the size of the emergency fund. However, despite the euro initially making gains due to the arrest of a slide in Chinese shares boosting risk appetite, by the end of the day there was still uncertainty over any increase to the size of the bailout fund and the Euro dropped after speculation that the Irish state may have to take control of the Bank of Ireland as it struggles to raise additional capital.

There were no indications that the ministers were closing down on any firm decisions yesterday. Jean-Claude Junker stated that they discussed many options but favoured none. There is pressure to work quickly before the euro suffers further losses.

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