British Pound in Focus Ahead of GDP, Current Account, Consumer Credit Data (Euro Open

The British Pound may see a volatile session in European hours, facing a busy economic calendar headlined by the final revision of Gross Domestic Product figures for the second quarter and also featuring reports on the Current Account and Consumer Credit.

[U][B]Key Overnight Developments[/B][/U]

[B]• Japan’s CPI Shrinks Again; Continued Deflation Threatens Economy, Currency
• Euro, British Pound Consolidate Near Familiar Levels in Overnight Trading[/B]

[U][B]Critical Levels[/B][/U]

The [B]Euro[/B] and the [B]British Pound[/B] consolidated near familiar levels in overnight trading, the former below 1.4650 and the latter below 1.5950, with the safety-linked [B]US Dollar[/B] relatively supported despite a formidable rally on Asian stock exchanges. We remain short GBPUSD at 1.6617 and EURUSD at 1.4710.

[U][B]Asia Session Highlights[/B][/U]

Japan’s [B]Consumer Price Index[/B] registered in line with expectations, showing prices shrank at an annual pace of -2.2% in August. More of the same is expected going forward, with a survey of economists polled by Bloomberg and the Bank of Japan both forecasting deflation through the end of next year. This bodes ill both for the economy and the currency. First, shrinking prices push up the real cost of borrowing, which is defined as the difference between nominal interest rates and the expected inflation rate; if the latter is (increasingly) negative, the difference produces an ever higher real interest rates, which encourage saving over spending and investment. Second, historical data suggests Japan’s real interest rate is inversely related with the value of the Yen, meaning that shrinking prices point weakness for the Japanese unit.

[B]Related Articles:[/B] Australia Books Record A$27.1 Billion Budget Deficit

[U][B]Euro Session: What to Expect[/B][/U]

The final revision of the second-quarter [B]UK Gross Domestic Product[/B] highlights a busy economic calendar in European hours. Expectations call for the quarterly figure to be revised slightly higher to reflect the economy shrank -0.6% in the three months to June versus the 0.7% originally reported, while the annual figure is revised to -5.4% from -5.5%. On balance, the improvement in the headline figure is probably too small to warrant any significant reaction from the currency markets, but traders will watch closely for any standout revisions in the major components of economic growth. Government spending had been the key driver of growth in the preliminary figures released in late August, adding 0.8% from the first quarter while private consumption and investment both continued to decline. This paints an inherently vulnerable picture of the UK economy, for surely the government’s support cannot endure with the fiscal deficit set to top 13% of GDP next year, sparking talks of a downgrade of the country’s sovereign credit rating. To that effect, the markets’ reaction will likely depend on where the upward revision in the headline figure came from.

The [B]UK Current Account[/B] deficit is set to narrow to -7.7 billion pounds in the second quarter from -8.5 billion in the three months to March. The release may garner more attention than usual this time after a report from the Bank of England argued for a fall in the “the long-run sustainable real exchange rate” as drying up capital inflows are unable to finance the current account shortfall. The Pound had been subjected to heavy selling pressure as the report hit the wires last week, so today’s release of a narrower deficit would seem to offer a bit of support to the beleaguered currency. However, it should be noted that consensus forecasts have been calling for the current account gap to fall as a percentage of GDP through 2011 for some time now, so one would assume that the BOE’s analysis had this consideration in mind and reached the same damning conclusion just the same. It remains to be seen how the data’s release plays out in the near term, but volatility seems like a distinct possibility.

Finally, [B]Net Consumer Credit[/B] is expected to yield a flat result in August after falling by a record -0.22 billion pounds in the previous month. The release will be watched in the context of talk that the Bank of England’s monetary easing efforts are set to take on a new direction after BOE chief Mervyn King said poor credit growth remains a direct drag on demand and revealing that policymakers are considering cutting the interest rate they pay on bank deposits to encourage idle reserves to be channeled into lending at a testimony to the House of Commons Treasury Committee earlier this month.

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