Interest rate expectations remained a very important influence over the week
Interest rate expectations remained a very important influence over the week and there were significant currency moves with a sharp reversal in trends from mid week.
Congressional testimony from Fed Chairman Bernanke was a key influence given the market focus on interest rates. Bernanke expressed concern over the near-term inflation outlook, although he also forecast a gradual slowdown in inflation over the next few quarters. Bernanke also warned over the risk of tightening policy too far and stated that policy lags must be taken into account. The testimony overall was softer than expected and the net result was that market expectations for an interest rate increase at the August Federal Reserve meeting dropped to around 50% at the end of the week from 90% the previous week.
As far as the inflation data is concerned, headline consumer prices rose 0.2% for June, while there was a 0.3% increase in core prices which pushed the annual core rate to its highest level for over four years at 2.6%. Core producer prices rose only 1.9% over the year, but with some evidence that inflationary pressure from high energy prices is being passed through to final goods prices.
The US growth data was mixed with strong figures for industrial production and an increase in capacity use to 82.4% for June being offset by generally weak survey evidence. There was a monthly deterioration in the New York and Philadelphia Fed PMI indices, although the price components remained high. The housing sector also showed evidence of a further slowdown with permits dropping to a 3-year low. The data for the week as a whole, illustrated the difficulties faced by the Fed in setting interest rates.
The dollar strengthened to highs beyond 1.25 against the Euro after the inflation data on Wednesday, but was subjected to renewed selling pressure after Bernanke’s testimony and the dollar weakened back to lows beyond 1.2650 on Friday as US interest rate expectations faded.
There was a sharp decline in the German ZEW index for July to 15.1 from 37.8 the previous month which raised some concerns over the growth outlook and retail sales data was disappointing, but the evidence suggests that business confidence is holding firm. ECB officials continued to take a tough stance on interest rates and inflation with markets still expecting a rate increase in August.
The UK data had a firm bias over the week with a 3.7% annual increase in retail sales for June while second-quarter GDP growth rose to 0.8% to give an annual increase of 2.6%. The consumer inflation data was stronger than expected, with a 0.3% monthly increase in prices pushing the annual inflation rate to 2.5% for June from 2.3% and moving further above the 2.0% Bank of England target. The MPC minutes from July’s meeting revealed a generally balanced view with caution over a near-term rate increase, but the inflation data reinforced market expectations that there would be a rate increase this year.
Sterling gained further support against the Euro with a move to highs near 0.6820 from 0.6950 at the end of last week while the UK currency also gained support from a retracement of dollar gains. Sterling pushed to highs near 1.86 against the dollar on Friday.
Middle East tensions remained a background influence but the overall market impact faded with a reduced flow of funds into safe-haven currencies. The easing of tensions reduced near-term support for the US currency and the Swiss currency also weakened to beyond 1.57 against the Euro.
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