Foreign Currency Exchange Market Analysis

BANK OF ENGLAND - between a rock and a hard place.

Today at 10.30 a.m. we have the release of the Quarterly Inflation Report accompanied by the post release Question & Answer session.

In a normal market the combined effects of downward pressure on consumption, tumbling consumer confidence, high street sales falling 1.5% year on year, multi million Pound write-downs from the residential property sector, a softening of the holiday booking industry and the threat from the recently nationalised Northern Rock that the Government will not get "our" money back for a lot longer would suggest that any inflationary pressures would be subsiding. Unfortunately that is not the case because inflation is rearing its ugly head. The strong output prices earlier in the week had set the stall and yesterday's CPI number came in at a shocking 3%. Mervyn & the team must be getting very worried that they will have to write another letter to the Chancellor explaining why inflation is running above 3%.

We would hope that the Bank of England is looking at the bigger picture and the slowing economic environment will drag the inflationary threat lower over time which in turn means there is still the potential for lower interest rates with a Bank Rate of 4.50% still targeted in this cycle.

There was a proliferation of comment from 5 Fed members last night, including the Chairman Ben Bernanke. All followed the same theme of inflation concerns and the need for a stable Dollar, but each with their own nuances. The most important of these additional comments in my view came from Fisher who stated that the Fed and the ECB were working together to ensure long-term confidence in the Dollar. The implications are that we have seen the top in EUR/USD for the foreseeable future at least (it topped out at just above 1.60 immediately following the last G7 meeting - the significance of which looks more important with each passing session).

The Foreign Exchange markets were reasonably quiet yesterday given the importance of the data and cable traded in a narrow 50 bp range for most of the day with even the much higher than expected UK CPI figure failing to drive it lower. The Dollar's strength overnight has succeeded in pushing cable down to the 1.94 level but a look at Sterling's performance against other majors underlines the fact that this latest volatility is Dollar based. This morning's moves will be dictated by releases from Eurozone and UK over a 30-45 minute spell. The Inflation report at 10.30 followed by the German IFO at 11.00 will be the catalysts that mould the rates early on (a BoE stance as anticipated and a weak IFO could see Euro/GBP lower) and the US CPI data at 1.30 this afternoon will likely be the precursor to further Fed comment and a stronger Dollar later.

We also see UK claimant count rate/jobless claims/average earnings/unemployment rate released at 9.30 These should provide further evidence of the UK economic slowdown and as such be the Rock to inflation's Hard Place that the MPC finds itself between.

Ensuring that inflation remains a thorn in everyone's side, the oil price continued its inexorable rise reaching a new high above $127 per barrel following rumours of production being reduced. This after the IEA had cut their estimates of global oil demand for the rest of the year.

The contents of this report are for information purposes only. It is not intended as a recommendation to trade or a solicitation for funds. Currencies Direct cannot be held responsible for any loss or damages arising from any action taken following consideration of this information.