The pound held firm yesterday as interest rate hike speculation gathered pace on the expectation of today’s UK inflation data showing double the MPC’s target of 2%. With this in mind, the BoE inflation report on Wednesday is expected to raise near term inflation projections, adding to the case for interest rate hikes prior to May. Higher interest rates are bullish for the pound in the short term as it makes it a more attractive prospect for investors seeking higher yields.
Sterling also received support due to a strong demand from Middle Eastern institutional buyers and positive merger and acquisition news, as the US behemoth General Electric announced it is set to snap up the John Wood Group for $2.8 billion. Despite the recent support for sterling in the market it is worth remembering that there are still concerns over faults elsewhere in the economy as poor jobs data on Wednesday and retail figures on Friday could trigger a sterling selling opportunity if we see a rise after the inflation data.
The greenback came under fire yesterday as Obama fuelled fears over the US trade deficit but the dollar could see a reversal in fortunes if we see a strong reading in today’s retail sales figures. Once the US President Barack Obama pledged to cut the US deficit to the tune of $1.1 trillion in the next decade the market focused on the size of the problem rather than the solution and the dollar sold off yesterday. However, investors are expecting buoyant US retail sales figures at 1:30PM today which could support the dollar and fuel a rise in US yields, increasing the chance of a dollar rally this afternoon. If we see good data it will increase the argument that the Fed is unlikely to extend its QE programme beyond June and push up US interest rates further when being priced in for 2012.
The euro fell against sterling and the dollar yesterday as concerns over sovereign debt issues re-emerged over struggling German Bank WestLB and poor Portuguese GDP figures. The euro was heavily sold yesterday as data showed that peripheral nations were still struggling with Portugal's economy contracting by 0.3% in the last quarter as the requisite austerity measures began to bite. The news was exacerbated by continued banking troubles in the larger nations as Germany’s West LB bank was forced to offload more assets in order to receive the EU aid it needs to continue. These worries all contributed to investors reining in expectations of a near term rate hike in the Eurozone.
Elsewhere in the Eurozone this week, uncertainty over a definitive long-term rescue package has seen peripheral yield spreads rising – highlighted to a meeting of finance ministers due Monday stalled. The 500 billion EUR package is due for 2013.