Markets stunned by GDP figure

The single European currency continues to rally against the
US Dollar, with the pair trading at two-month highs. The Greenback suffered as
President Obama called for a freeze on non-security discretionary spending
during his State of the Union speech last night, suggesting a part spending
freeze that would save $400 billion from the budget over the next decade and
additional cuts of $78 billion in defence. There was a minor reaction in
markets to the speech, previously that day a report indicated that US consumers
began the year with much more confidence in the economy than expected, seeing a
recovery gaining steam and expecting more jobs will be created. The Conference
Board said its consumer confidence index, which had slipped in December, rose
in January to 60.6, its highest level since May. In contrast US Housing data
also released showed a mini double-dip in home prices. Residential real-estate
prices dropped in November by the most in a year. According to the S&P/Case-Shiller
index, home values in 20 cities fell 1.6 percent from November the prior year,
the biggest 12-month decrease since December 2009.

The pound was dealt a severe blow yesterday as the UK economy surprisingly contracted
in the fourth quarter of 2010 as the harshest winter in a century hit retail
and service sectors. GDP fell by 0.5% in Q4, having increased for the last 4
quarters, according to the Office for National Statistics yesterday morning.
The ONS said that growth would have been “flattish” in the fourth quarter
without the impact of the weather and that weather-related disruptions
accounted for “most” of the 0.5% decline. This view has been echoed by the
words from Mervyn King last night who played bad cop / bad cop all on his own.
There were no soothing words at all with expectations that rising consumer
inflation would remain a problem but that wages in real terms would fall – he
warned the UK
to expect living standards to fall with the likelihood that things would not
improve much for the rest of 2011.

The focus today will now shift to the upcoming FOMC
statement with no change in near-term monetary policy expected. However,
investors will be focussed on the inflation outlook language and whether any of
the new voters on the committee dissent in a hawkish direction. Losses in the
dollar were tempered last night on speculation the Federal Reserve will signal
the world’s largest economy is improving. The FOMC statement may contain
language acknowledging improvement in consumer spending and employment.

Report by Philip Ryan