Connect with this author on Google+

by Adam Solomon

Sterling / Euro and US Dollar

The Pound rallied to the highest level against the U.S Dollar in 13-months yesterday in the foreign exchange rate markets, breaching the $1.63 level, while the UK currency also made gains against the majority of the 16 most actively traded currencies, including the Euro. Sterling began the day on the front foot, after a report from the Nationwide Building Society showed that UK house prices unexpectedly rose in February.

A separate report showed that manufacturing output also increased to a record high in February, boosted by recent speculation that the Bank of England will raise interest rates over the coming months. The report from the Chartered Institute of Purchasing and Supply showed that an index of manufacturing remained unchanged from the previous month, matching the record high since comparable records began in 1994.

The Pound surged higher following the data and speculation over the timing of a rate hike will continue to underpin Sterling sentiment over the coming month. In early April, the Bank of England will have the preliminary set of first quarter results in the UK and if the economy recovers from the fourth quarter contraction, the probability of a rate increase by May will increase significantly.

However, a number of officials and commentators are warning that an interest rate increase over the coming months would be incredibly damaging to the UK economy. The governor of the Bank of England Mervyn King was speaking to the UK Treasury Select Committee yesterday and warned that a rate hike now would be a mistake.

The Pound also advanced against the Euro, rising back above 1.18 in London, while the UK currency rallied up towards 2.20 versus the New Zealand Dollar, as global risk appetite declined following the continued spate of unrest in Libya and the Middle East. Sterling has advanced 4.3% against the Dollar this year on mounting speculation that policy makers will begin to tighten monetary policy to contain inflation.

Consumer prices accelerated to 4% in January and have remained above the government’s upper limit of 3% for 14-months in a row. King has also conceded that consumer price growth may peak at 4.4% this year, before ambling back towards the 2% target in 2012. His MPC colleague Andrew Sentance has warned that this forecast is overly optimistic.

Sentance leads the calls for the central bank to lift interest rates and has voted for an increase on every occasion since June last year. In February, he voted for an immediate 50 basis point hike and the minutes from last month’s policy meeting showed that Spencer Dale and Martin Weale joined the crusade for higher borrowing costs, each voting for a 25 basis points increase.

King was forced to write his fifth letter of explanation to the Chancellor of the Exchequer George Osborne explaining why the rate is above the 3% upper limit “through the rest of this year.” King said yesterday that a rate increase as a gesture to fight inflation would be “self-defeating.” He also stated “I don’t believe we’ve yet seen significant evidence of a pick-up in medium-term inflation expectations.”

Mervyn King’s reluctance to concede that rising inflation needs to be contained did little to support the Pound yesterday and his comments were largely ignored by the market. Speculation has reached fever pitch on the timing of the first rate increase this year, with money markets pricing in up to three quarter-point rate increases over the course of the year.

Also speaking yesterday Charles Bean, the deputy governor of the Bank of England, said in parliament that the affect of a weaker Pound on UK consumer prices was bigger than anticipated. The UK currency has weakened 18% against the U.S Dollar since the end of 2007, but the move above 1.63 to the highest level in 13-months makes it increasingly likely that the Pound will continue its upside momentum in the near-term.

Finally, the Pound also found support yesterday, after a report from the Bank of England showed that UK mortgage approvals rose more than expected in January. Lenders granted 45,723 home loans, compared with a 22-month low in December, and the report provides further evidence that the UK property market is improving.

Euro / US Dollar

The Dollar rallied for a second successive day against the Euro as global stocks declined and continued unrest in North Africa and the Middle East saw oil prices close to $100 a barrel. Concerns that the global recovery will come under pressure has spurred demand for the Dollar and the Yen as safe havens and in an environment of risk aversion, the U.S currency will continue to benefit.

The Dollar actually advanced against 12 out of the 16 most actively traded currencies in the foreign currency exchange markets, as Libyan rebels braced themselves for renewed clashes with forces loyal to the current regime. The U.S currency traded close to 1.3750 against the Euro, but declines in the single currency will be limited ahead of the European Central Bank announcement on Thursday.

The ECB are expected to indicate that interest rates will be increased to contain rising inflationary concerns and the tone and language used in the accompanying press conference will take on added significance. The New Zealand Dollar declined to the lowest level this year, after the Prime Minister John Key said that he expected a cut in the nation’s benchmark interest rates.

Data Released

EU 10:00 Producer Price Index (January)

U.S 13:15 ADP Employment (February)

U.S 19:00 Federal Reserve Bank publishes Beige Book