Euro Continues Higher; British Pound Propelled By King

• JPY Industrial Production better than expected
• EUR Continued strength from GDP news
• GBP UK unemployment below 3.0% but wage gains muted
• USD Retail Sales and Bernanke on tap

The euro continued its assent in early European trade today with the pair testing the 1.3100 level as the positive ramifications of yesterday’s better than expected GDP growth continued to resonate through the currency markets. The latest European business group to raise GDP estimates was the German chambers of industry and commerce (DIHK) which increased their forecast for 2007 to 2.3% from 1.5%. In contrast to this EZ positive news, yesterday’s higher-than-expected US Trade Balance deficit and the bigger-than-forecast draw in US inventories last Friday suggest that the initial 3.5% estimate of US 4Q GDP will likely be revised downward. It fact its quite plausible that after final adjustments are made. EZ GDP will exceed US GDP for the third consecutive quarter. Little wonder then than German business confidence rose to its highest level since 1991.

Meanwhile across the pond the pound went on a wild ride first diving below 1.9500 on the relatively dovish comments of the BOE Quarterly inflation report which stated that inflation is likely to return to 2.0% by end of 2007 as energy prices cool off. However, shortly thereafter comments by BOE president Mervyn King put the bid back into cable when he noted that the inflation forecast remained highly uncertain, suggesting that the bank will remain proactive in controlling future price risk. Mr. King’s words quickly convinced the market that the UK central bank continues to maintain its hawkish bias and will be willing to raise rates again at any hint of further increase in price pressures. The EURGBP cross which reached 6720 by the London open, quickly dropped 30 points – a day’s worth of trade – in a matter of only 15 minutes.
Mr. King’s warning notwithstanding, the latest UK data, while generally positive, could hardly be called inflationary. UK claimant count posted very strong results, shrinking by far larger than expected -13.5K as the unemployment rate dropped below 3.0% for the first time since February of 2006, but wage gains remained muted with manufacturing labor costs actually contracting. With both PPI an CPI gauges decelerating markedly, the only possible threat of inflation resides in the UK housing market, and housing prices would have to resume their double digit gains before BOE would be compelled to take action. Therefore, given the current of affairs we do not envisage additional rate hikes by BOE in the near future and believe the market may reading a tad too much into Mr. King commentary.