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Wednesday February 13, 2008 - 12:20:18 GMT

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Forex Research - Pound Bounces, BoE Remains Hawkish Suggesting Cuts Will Be Limited

Wednesday, 13 February 2008 12:00:17 GMT

Written by Boris Schlossberg, Senior Currency Strategist

UK labor markets recorded surprising strength as jobless claims declined by -10.8K versus -5.0K projected.

Talking Points

•    Japanese Yen: Trades to 107.50 as carry flows return
•    Euro: IP weaker could hurt GDP data later in the week
•    British Pound: Labor market hot, BoE cautious
•    US Dollar: Advance Retail Sales on tap

Pound Bounces, BoE Remains Hawkish Suggesting Cuts Will Be Limited

UK labor markets recorded surprising strength as jobless claims declined by -10.8K versus -5.0K projected suggesting that the current turmoil in financial markets is having little negative impact on employment for the time being. With unemployment rate remaining steady at 5.2% while wages continued expand at a healthy 3.7% annual pace, UK economy is showing few signs of  serious economic slowdown. The one exception is the housing sector which continues to deteriorate materially  as asset prices in the latest RICS survey showed a decline of 54.7% vs. 52.5% expected.

Pound rallied on the positive labor markets news, however what really boosted cable in early morning European trade was the resoundingly hawkish inflation report from the BoE. For more info please read British Pound Gains as the Bank of England Suggests Future Rate Cuts Will Not Be Aggressive. The UK monetary authorities acknowledged that steep declines in asset prices posed downside risks to growth which could be exacerbated by tighter credit conditions. Nevertheless, the bank cautioned that an aggressive monetary easing campaign could stoke further inflation pressures which MPC officials consider to be anathema to the UK economy. Governor King went out of his way to emphasize that he was “very, very determined to get CPI under control.”

In short tonight’s message from the BoE provided a clear signal to the currency markets that any easing will be gradual and cautious in nature. Traders should not anticipate any dramatic moves from UK authorities a la Fed’s recent 75bp and 50bp cuts. Instead the BoE is far more likely to lower rates in small increments of 25bp at time  perhaps pausing several month pause in between each move.

Of course Governor King’s mettle will be tested should UK economic conditions suddenly turn for the worse. For now the monetary authorities can enjoy the political protection offered by relatively buoyant labor markets. However, should that situation change the BoE  will become far more accommodative  and 50bp rate cuts could  be back on the agenda by next quarter. The currency traders seemed to have sensed this possibility and cable rallied only modestly in the aftermath of the release. Nevertheless, for time being the path of least resistance for sterling is up as some of the bigger worries about the health of the UK economy  have been alleviated.

In North America trade today the ,marquee release will be the US Retail Sales numbers. Conventional wisdom suggests that it may miss to the downside given the horrid auto-sales results in January. However, this release  is notoriously difficult to handicap and furthermore may be dismissed by the market as “yesterday news” reflecting the gloomy bottom of consumer attitudes that prevailed in January.  Although recent US economic data has been anything but positive, financial markets may be focusing on the latest news regarding Warren Buffets possible rescue of the monocline insurers.  In short if equity markets remain positive in spite of a weak Retail Sales number, the high yielders amongst the majors should continue to rally against the greenback as carry flows continue.

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