British Pound Advances as Bank of England Votes Unanimously, Euro Stalls Ahead of 1.4

Cable advanced against the euro and the U.S. dollar as the Bank of England held an enhanced outlook for the UK economy, and the British pound may continue to retrace the decline from earlier this month as growth prospects improve.

[U][B]Talking Points[/B][/U][B]
• Japanese Yen: Losing Ground Across the Board
• Pound: BoE Votes 9-0 to Maintain Current Policy
• Euro: Fails to Hold Ground, Pulls Back From Yearly High
• US Dollar: FOMC Interest Rate Decision on Tap[/B]

Cable advanced against the euro and the U.S. dollar as the Bank of England held an enhanced outlook for the UK economy, and the British pound may continue to retrace the decline from earlier this month as growth prospects improve. At the same time, a report by the British Bankers Association showed loans for home purchases slipped to 38,095 in August from 38,186 amid expectations for a rise to 40,500, and tightening credit conditions paired with the downturn in employment is likely to weigh on the economic outlook as policy makers see a risk for a slower recovery.

Meanwhile, the Bank of England minutes showed the MPC voted unanimously earlier this month to hold the benchmark interest rate at 0.50% and to maintain its GBP 175B asset purchase program to encourage a sustainable recovery, and turned slightly hawkish as the board projects “inflation would probably be higher in the short-term than the committee had thought a month ago.” Moreover, the BoE went onto say that the rebound in economic confidence paired with the improved outlook for asset prices “could mark the start of a virtuous upward spiral for the economy” however, the board held a caution tone and warned that there could be “false dawns” as the economy has yet to reach “the point where the level of spare capacity was shrinking.” As a result, policy makers argued that “a larger asset-purchase program could still be justified” as the economic outlook remains weak, and expects price growth to be “extremely volatile” over the coming months as the board anticipates an upward revision in the 2Q GDP reading. The comments suggest the central bank will maintain its current policy throughout the second-half of the year as the outlook for growth and inflation improves, and the British pound may snap back against its currency counterparts as investors raise long-term expectations for higher interest rates in the UK.

The euro weakened against the greenback after reaching a fresh yearly high of 1.4844 during the Asian session, and the pair may hold steady over going into the North American trade as the markets await the FOMC interest rate decision. Nevertheless, the economic docket showed manufacturing activity in Germany fell at a slower pace in September, with the advanced PMI reading rising to 49.6 from 49.2 in the previous month, while service-based activity expanded at a slower pace during the same period as the PMI unexpectedly slipped to 52.2 from 53.8 in August. At the same time, the manufacturing PMI for the Euro-Zone increased to 49.0 from 48.2, with the services PMI advancing to 50.6 from 49.9, while the composite reading tipping higher to 50.8 from 50.4 amid expectations for a rise to 51.3. The data encourages an enhanced outlook for the region and conditions should continue to improve over the coming months as policy makers take unprecedented steps to stimulate the ailing economy however, the European Central Bank is likely to hold a dovish tone going into the following year as Governing Council member Ewald Nowotny anticipates an L-shaped recovery in the Euro-Zone. Moreover, industrial new orders in the Euro-Zone increased 2.6% in July amid expectations for a 2.0% rise, while the annualized rate slipped 24.3% from the previous year after falling 25.7% in June. The breakdown of the report showed demands for durable goods surged 5.6% after falling 2.0% in the previous month, while orders for capital goods increased 2.9% to mark the second consecutive rise. As the economic outlook for Europe improves, the single-currency may continue to outperform as the ECB maintains a neutral policy however, we are likely to corrective retracement over the near-term as the euro-dollar remains overbought.

The U.S. dollar continued to weaken against its major counterparts during the overnight session as investors increased their appetite for higher-yielding assets, and the reserve currency may face increased volatility throughout the U.S. trade as the FOMC is widely expected to hold the benchmark interest rate at 0.25% and maintain its $1.75T asset purchase program in order to encourage a sustainable recovery. At the same time, market participants speculate the central bank to signal an end to its easing cycle as Fed Chairman Ben Bernanke sees the economy emerging from the worst recession since the post-war period, and comments following the meeting are likely to shake up the markets as investors weigh the outlook for future policy.

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[I]To discuss this report contact David Song, Currency Analyst: <[email protected]>[/I]