Dovish MPC Shocks Market But Pound Barely Bruised

Talking Points
• Japanese Yen: Markets closed for holiday
• Swissie: Trade Balance improves materially
• British Pound: 8-1 MPC vote shocks market
• US Dollar: FOMC on tap

Dovish MPC Shocks Market But Pound Barely Bruised
With Japanese capital markets closed for holiday, Asian session trade was predictably quiet, but activity picked up markedly when London came on line as carry trade flows once again pushed the yen lower against most of the high yielders. With kiwi above 7000 and Aussie maintaining its 8000 level the hunger for yield continues to dominate order flows in FX. The carry trade is helped in no small part by the buoyancy of the equity markets as the Dow Jones Industrial Average continued its rally yesterday rising for the 4th time out the past 5 sessions. It appears that as long as equities remain steady, risk seeking behavior in the currency market will continue to keep the carry trade in tact.
The pound has been a tremendous beneficiary of the carry trade flows this week, especially after yesterday hotter than expected CPI numbers, but today sterling caused a sharp surprise as traders were taken aback to see that last months MPC vote was 8-1 in favor of keeping rates steady. The market was forecasting a 7-2 vote with possibly two hawkish members arguing for further rate hikes. Instead the sole dissenter, David Blanchflower, turned out to be a dove, voting for a rate cut instead. Nevertheless after the initial shock, and a quick drop in the pound, the markets quickly rallied sterling across the board on the assumption that the BoE was operating on stale data, and that the latest figures which show double digit increases in housing prices and a rise in the overall inflation level will once again convince the UK central bankers to become resolutely hawkish.
As stated yesterday, we continue to believe that the key to the cable bullish case will be tomorrow’s UK Retail Sales numbers. If the UK economy is as vibrant as many pound longs believe, consumer spending should confirm that thesis. The market is forecasting a healthy rebound to 0.6% from a decline of -1.8% the month prior. If UK Retail Sales meet or beat expectations, an April rate hike will become a distinct possibility. However, a sharp miss would squash any hopes of BOE tightening in the near future, and the pound may well see its powerful two day rally come to an abrupt end.

In the US today we will have the FOMC meeting, which normally is volatile event in the FX market. However, today’s session may produce much heat but little light as prices could simply seesaw around the 1.3300 level. The Fed is unlikely to waver far from its past statements and may in fact issue a hawkish message, emphasizing the recent rises in US inflation. It will be interesting to see if US monetary officials choose to comment on the the recent troubles in the US sub-prime market. If the Fed ignores that subject, the market may feel a bit more dollar bullish, interpreting the Fed position as one that sees little widespread US economic fallout from the housing sectors current troubles.