Foreign Exchange Daily Market Update 24/05/11

The Pound fell against the Dollar and the Euro yesterday as foreign exchange traders scaled back their appetite for risk. The Bank of England's (BoE) Chief Economist, Spencer Dale, voiced his opinion on UK inflation in an interview yesterday with the Financial Times (FT). Dale stated that the BoE should raise interest rates gradually over the next two years as a means of combating inflation, and as such has been voting for a 25 basis point hike in the interest rate for the past 3 policy meetings, alongside fellow MPC member Martin Weale. Dale said in the FT - "I don't take lightly the impact this (possible rate hike) could have on some families. But I think the cost to our economy as a whole - were inflation to persist for longer and our credibility start to be eroded - would be even worse." Dale's statement does go some way to support the possibility of the BoE raising the interest rates at some point over the next 12 months, and this expectation could well provide some support for the Pound over the coming months.

April's Public Sector Borrowing and Public Finance figures headline the UK's economic docket today. Expectations call for government borrowing to fall from £16.4 billion to £4.4 billion, which would be a positive sign for the economy and in turn the Pound. So should the figure fall in line with estimates, expect to see the exchange rate improve.

A weakened outlook and sovereign debt fears continued to weigh on the Euro yesterday with the Dollar making early gains against the single currency. The Euro's decline was not helped by worse than expected readings for Euro-zone and German Purchasing Managers Indexes (PMI) for April. Germany's index readings for service and manufacturing based activity fell to 54.9 and 58.2 respectively, missing estimates for readings of 57.0 and 61.0. For the Euro-zone manufacturing activity slowed with a PMI of 54.8 down from 58.0 and service based activity slipped from a reading of 56.7 to 54.9, bringing the composite index down from 57.8 to 55.4. The outcome would suggest that the Euro-zone is suffering from the effects of a slowdown in the global economy.

The currency exchange market has already seen a heavy dose of European data this morning, the most influential of which being Germany's final revisions to first quarter GDP. The revision showed that the economy expanded at a rate of 1.5% quarter-on-quarter, which was in line with preliminary readings, while annually the economy had grown by 5.2%. Despite the economy growing as expected, the individual components of the GDP figure were mixed resulting in the Euro currency's decline upon release of the data. One note of worry was that private consumption, investment in construction, and domestic demand of German goods came in well below expectations.

On a more positive note, Germany's IFO business sentiment gauges came in higher than expected. The current assessment index showed that German business remained as confident as last month about present conditions, when the index edged up 0.4 to 121.4, while the outlook for the next 6 months remains relatively weak with the future expectations gauge slipping slightly from 107.7 to 107.4. Lastly, new industrial orders in the Euro-zone are expected to have contracted in the month of March by 1.1% sequentially from February's 0.5% reading. Like yesterday's manufacturing PMIs, the decline of industrial orders points suggests that the slow down in the global economy is affecting the Euro-zone.

Falling risk sentiment boosted the Dollar's standing against the other majors yesterday, as it benefited from its status as a safe haven currency. The fall in risk appetite has been stoked by the sovereign debt crisis in the Euro-zone and perhaps more importantly, by the economic slowdown in China. As the world's second largest economy, China is considered very important in gauging the health of the global economy. News overnight showed that China is set to miss GDP estimates for 2011 as Premier Win Jiabao's campaign to rein in inflation is restraining growth in the economy. Published in today's Economic Information Daily were comments from government researcher Ba Shusong saying he's "concerned about a policy over-adjustment" as "China's economy faces a risk of an excessive downturn" if the central bank's tightening measures last too long.

Housing data from the US makes an appearance on the economic calendar today. The sale of new homes in April is expected to rise by 1.7% to bring the annual total to 305,000 units sold from 300,000. However, given that last week saw existing home sales slump over the same period and both building permits and housing starts contract, the possibility that new home sales will fall below expectations is very real. If the outcome comes inline with analysts' expectations then the Greenback is likely to find support, however if the figure falls below the consensus then the currency could see potential weakness.