Bank of England Minutes Could Save the British Pound

DailyFX Fundamentals 02-19-08

By Kathy Lien, Chief Strategist of DailyFX.com

What are the Best and Worst Performing Currencies Against the US Dollar?

With President's Day now behind us, volatility has returned to the currency and stock market. Having been up over 100 points intraday, the Dow Jones Industrial Average ended the day down 10 points. Long gone are the days of universal dollar strength or weakness. The US dollar sold off against most of the major currencies except for the British pound and Canadian dollars. The best performing currency today was the Australian dollar and Swiss Franc which benefitted from the $22 dollar jump in gold prices and signs that Australian interest rates will head higher. The Canadian dollar and the British pound on the other hand were the worst performing currencies against the dollar because next to the US, the most aggressive easing is expected to come from the UK and Canada. We only see cohesive price action when central banks around the world employ the same monetary policy of raising or lowering interest rates. Unfortunately when we have the Reserve Bank of Australia raising interest rates and the Bank of Canada lowering them, trading currencies has become much more complicated than being pro dollar or anti dollar. Tomorrow we have consumer prices due for release. Food and energy prices have been on a tear and for those reasons we expect consumer prices to rise as well. If CPI surprises to the upside, the best trades to take may be long USDCAD and short the GBPUSD. If CPI disappoints, expect the Australian dollar to continue to be one the currency market's best performers. The NAHB housing market index rebounded in the month of February due to an increase in buyer traffic. We do not that think the rise in the homebuilder's survey will be repeated in building permits and housing starts. With interest rates and house prices declining, bottom fishers are slowly beginning to sniff out the inventory, but just because they are sniffing does not mean that they are buying.

Bank of England Minutes Could Save the British Pound

There has been no data released from the UK today and as we expected, the Northern Rock story continued to weigh on the British pound. Nationalization is never good news for a developed country and the credibility of the UK government which has already been dealt a serious blow will come under more fire in the coming weeks. In the meantime, there could be a potential for a British pound recovery over the next 24 hours. The Bank of England will be releasing the minutes from their latest monetary policy meeting, along with money supply figures and the CBI Industrial Trends Survey. Although the Bank of England cut interest rates by 25bp earlier this month, the accompanying statement and Quarterly Inflation Report released last week was not extremely dovish. Even though BoE Governor King recognized the downside risks to growth in the Quarterly report, he raised the bank's inflation forecast and warned that near term inflation will continue to breach their 2 percent goal while running the risk of breaching the government's 3 percent limit. If inflation rises beyond 3 percent, King would be obligated to write a letter of explanation to Alistair Darling, the Chancellor of the Exchequer. With this even being a remote possibility, it will be difficult for King to justify another rate cut.

Reserve Bank of Australia Considered a 50bp Rate Hike?!

According to the minutes released by the Reserve Bank of Australia last night, the central bank actually considered raising interest rates by 50bp earlier this month. Since the middle of January, the Australian dollar has rallied over 600 pips because Australia is the only developed country that is raising interest in an environment where everyone is else is lowering them. Today's announcement is icing on the cake for Australian dollar bulls. With a booming economy and rising inflation pressures, the RBA only opted to raise rates by 25bp because the financial markets are still unstable and they can always tighten further in March. Central bank Assistant Governor Edey expects inflation to continue to rise, which means that another 11 year high in interest rates is practically a given next month. The Canadian dollar on the other hand fell sharply today disappointing CPI and wholesale sales numbers. Despite the fact that oil futures touched $100 a barrel intraday, the Canadian economy is getting progressively worse while the strength of the Australian economy continues to catch everyone by surprise. For that reason, on a percentage basis, AUD/CAD was the day's best performing currency pair.

Euro Strengthens Ahead of Inflation Report

One of the main reasons why the European Central Bank refuses to cut interest rates is inflation. Tomorrow, their hawkish stance may be validated by the German producer price report, which should have increased materially last month. Like the rest of the world, the Eurozone will be affected by the recent rise in food and energy prices. The futures market currently expects the European Central Bank to cut interest rates by 50 to 75bp this year. German PPI will help to determine whether those expectations are overly aggressive. Meanwhile, the Swiss franc is stronger across the board thanks to the rise in gold prices and the optimistic tone of the Swiss National Bank. According to their annual report, the SNB believes that the private consumption will remain strong, leaving a favorable outlook for the Swiss economy.

Carry Trades Still Struggling

Since the beginning of the month, the Yen crosses have been trapped within a wide trading range, making it frustrating and difficult for anyone still long carry. In fact, the only carry trade currency that is trading at a level higher than it began this month is AUD/JPY. Volatility in the financial markets continues to be very high, which has made it very difficult for carry trades to recover. We believe that this will remain true until we see some stability in the US economy.