In this week’s dollar update from Moneycorp:
MPC minutes raise spectre of further quantitative easing. UK public borrowing much higher than expected in July. Safe-haven dollar hampered by decent data and confident investors.
Sterling first dipped half a cent from Monday’s $1.6350 starting point before beginning a rebound that took it up to $1.66 on Tuesday. It spent the rest of the week between there and $1.64, fairly well-supported but showing no sign of putting together a serious rally. It opened in London this morning at $1.6450.
Although there were very few UK economic statistics and events on last week’s agenda, three of them turned out to be quite significant. Tuesday’s Consumer Price Index data delivered the first surprise. With inflation fading over the past several months a further decline was expected, from +1.8% to +1.6%. It turned out that prices had remained static between June and July, leaving the annual rate of inflation unchanged at +1.8%, still close to its 2% target. There were raised eyebrows all round and the market’s instant reaction was to buy the pound: if inflation was not still going down could this mean that interest rates might have to go up?
The following day’s minutes of the August Monetary Policy Committee meeting had the opposite effect. Investors had already been taken aback by the committee’s decision earlier this to increase by £50 billion the size of its Asset Purchase Facility (quantitative easing, “printing money”). When they saw in the minutes that the Governor himself had been outvoted in an attempt to increase the programme by an even larger amount – £75 billion – they took a dim view. The Bank of England has confused financial markets with its stop-start signals about monetary easing and markets do not like to be confused, especially by central banks.
The third bouncer came with Thursday’s money supply figures. July is normally a good month for the Treasury, with tax receipts exceeding public spending. Expectations were lower than usual because of the recession, but investors were not ready for the £8 billion jump in public sector net borrowing that suddenly confronted them. Everyone knows that the government is planning to borrow in the next few months as much as previous governments have borrowed in total, ever. Given that, it is not immediately obvious why everyone was so surprised but they certainly were surprised, and unpleasantly so. It made for a most uncomfortable end to the week for sterling.
There were no particular shocks for the US dollar over the week but its life was hardly less uncomfortable. If anything, it was the absence of shocks that made its life difficult. Financial markets have returned to the position whereby the US dollar and the Japanese yen are only in demand when the going gets tough. The US data were by and large positive, giving investors nothing to fret about. Federal Reserve banks in New York and Philadelphia both reported improvements in their manufacturing indices that took them above zero and into the expansion zone. The Treasury’s TIC report on capital flows showed a bin inflow of investment in July. Although housing starts were slightly fewer than expected existing home sales jumped by more than 7% in July.
Whilst these figures all contributed to a rosier – or at least less bleak – picture of the US economy they also contributed to the investor confidence that still works against the dollar. An upbeat speech by Federal Reserve Chairman Bernanke on Friday was similarly unhelpful to the US currency.
Even the bad news did not help. On Wednesday the world’s biggest bond fund and the world’s richest man both – coincidentally – expressed concern about the size of the US budget deficit. Pimco said the dollar would weaken as the government pumps “massive” amounts of money into the economy. Warren Buffett said the currency would suffer unless the government deals with the side effects of the “monetary medicine” it has recently administered. Investors saw both comments as negative for the dollar.
Having achieved its $1.63 target sterling is waiting to see what happens next. That it bounced from $1.63 must be seen as good news but the resistance at $1.66 has quickly become solid. A relapse to below $1.63 could mean at least another three cents of retreat while a break of $1.66 would open the way to $1.70. In its current three-cent range there is no case to be made in either direction so buyers of the dollar should stick with their existing hedge strategy of 50% or more.
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