Pound Slaughtered Ahead of Rate Decision

[B]- Japan: Eco Watchers slips below 50

  • Euro: Wholesale prices at six year highs
  • Pound: Trade Balance and IP weak
  • US Dollar: Trade on tap[/B]

Pound Slaughtered Ahead of Rate Decision
UK data showed further deterioration as the Trade deficit widened to more than -7 Billion pounds while the bounce in Industrial Production was weaker than expected printing at 0.3% vs. 0.4% consensus. The news suggested that UK GDP estimates for Q2 may be revised lower, and slashed any hope of a surprise 50bp rate hike by the BoE. Therefore, despite the anticipated 25bp rate hike later today which normally would be bullish for the currency, the pound was sold quite heavily in early London trade as speculators wondered if this might be the last rate hike from the UK central bank for the foreseeable future.
The news of Tony Blair?s retirement, which will be announced today but will not actually take effect until June, may be contributing to pounds weakness as well. Although Gordon Brown, the Prime Minister?s expected successor is well respected, the gap between Mr. Blair?s announcement and departure date leaves a power vacuum in UK politics at the time when the ruling Labor party has seen serious declines in its public approval ratings. In short, tonight?s price action setup the classic sell the news dynamic in the market with overnight economic and political news only serving to embolden the shorts. Nevertheless, the rate hike, if it comes as expected should provide strong support for cable, especially against the low yielders such as the yen. With GBP rates at 5.50% the GBPJPY cross spread differential will widen out to 500 basis points and should attract further carry trade flows.
In the meantime, yen?s weakness was exacerbated in overnight Tokyo trade on news that the Eco Watchers survey fell below 50 boom bust level once again. The survey, which many of you know is our favorite gauge of Japanese consumer strength, registered a reading of 49.7 vs. 50.4 projected. After climbing into positive territory in March for the first time in 6 months, the index once again contracted highlighting the long term structural problems of Japan?s economy. While Japan?s export driven corporate sector continues to perform well, the jump in profits is not translating into an increase in wages as Japan, like all industrialized nations is subject to brutal labor cost pressures from China.
The net effect of this dynamic is that the recovery in Japanese consumer spending has been anemic at best, curbing the BoJ ability to raise rates further and pushing the yen lower as carry trade continues unimpeded. Therefore, even tonight?s hawkish commentary by Governor Fukui warning about the negative long term consequences of low rates had little impact on the yen as Japanese monetary authorities remained handcuffed in their policy choices.