British Pound - Hit by Blowup in US Sub-Prime Lending (page 1 of 2)

DailyFX Fundamentals 02-08-07

By Kathy Lien, Chief Strategist of DailyFX.com

US Dollar
Even though there was no US data to drive market activity today, there was quite a bit of interesting price action. The main event was the press conference after the ECB meeting. Interest rates were left unchanged, but as soon as the words "strong vigilance" came out of Trichet's mouth, the ECB's hawkish bias was set and bullishness was instilled in the Euro. The behavior in the British pound however was very different. The currency collapsed after the Bank of England left interest rates unchanged. It appears that more than a small minority may have been expecting an interest rate hike. The Australian and Canadian dollars rallied thanks a rise in commodity prices while the New Zealand dollar collapsed after Finance Minister Cullen said that he was considering imposing a mortgage levy to curb the growth of the housing market. The action has been in the crosses with typically range bound pairs like the EUR/GBP and EUR/CHF seeing unusually large moves. The Tier 2 US data released today pretty much offset each other. Wholesale inventories fell short of expectations while wholesale sales were stronger than expected. Jobless claims were slightly higher, but remained at levels that were indicative of limited job losses. Tomorrow's market activity should continue to be driven by factors outside of the US since no economic data is due for release. We expect the most interesting movements in the Japanese Yen as traders adjust their positioning ahead of the G7 meeting.

Euro
Thanks to the comments from European Central Bank President Trichet, a March interest rate hike is a near guarantee. The central bank President was far more hawkish this morning than he was at the last monetary policy meeting where he set the market up for today's unchanged rate decision. Trichet plays his cards well and after the latest pause he is now telling traders to expect one rate hike in March and possibly another one shortly there afterwards. Even though he felt that inflation could slow in the spring and summer, he expects it to accelerate again in the second half since Germany's Value Added Tax increase has yet to be reflected in consumer prices. The economic expansion also remains solid and the outlook for consumption is promising. Therefore unless we see a material slowdown in Eurozone growth, interest rates could reach 4 percent by the end of the year. Furthermore, Trichet clearly indicated that the ECB is independent and will not be influenced by Eurozone finance ministers. His lack of concern for carry trades suggests that they will not be stopping rate hikes just to stem the rise in EUR/JPY.

British Pound
The Bank of England's decision to leave interest rates unchanged triggered a major sell-off in the British pound against the US dollar, Euro and Japanese Yen. The most interesting aspect of today's move is the fact that trader positioning was so misaligned with analyst expectations. Given the narrow vote that supported the last rate hike, there was little chance for a follow-up move today. However the sharp divergence between UK and Eurozone monetary policy has earned EUR/GBP the status as the day's most market moving currency pair on a percentage basis. The sell-off in the GBP/USD was exacerbated by a report from the Wall Street Journal that UK based HSBC was forced to set aside 20 percent more capital (most likely in US dollars) to cover the delinquencies in the US sub prime mortgage market.