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Tuesday April 20, 2010 - 14:51:10 GMT
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U.K. Inflation Surges; Economists Questioning BoE’s Deflationary Outlook

A better-than-than expected surge in U.K. Consumer Prices raised questions about the recent assessment by the Bank of England that a deflationary trend was going to emerge because of the weak economy. The BoE recently commented that the short-term rise in inflation over the past two months amounted to an aberration and that deflation was the real threat.


The GBP USD rallied into a major .618 retracement level following the news that British inflation rose in March to 3.4% from 3.0% in February. This unexpected hike in consumer prices makes it unlikely that the BoE will increase the amount of quantitative aid at its next meeting on May 6th. Gains could be limited today because of lingering concerns over the possibility of a hung parliament after the May 6th election.


Speculation that Greece may require additional rescue aid to finance its economy could weigh on the Euro the rest of this week. At this time, the EUR USD is trading better; this could change following the New York opening. Additional factors that could hurt the Euro’s performance are ongoing travel disruptions in Europe because of the volcanic eruption and the widening Greek government/German Bund spreads.


The spread of volcanic ash over Europe could develop into a major economic problem for the Euro Zone economy if the eruption turns into a long-term issue. This natural disaster could wreak havoc on the economies in the Zone leading to delayed interest rate hikes and expected fiscal tightening. While the rest of the world will be hiking interest rates, the European Central Bank may be forced to wait until the economy shows a sustained improvement.


Although it was reported that German investor confidence improved more than forecast this month, the lingering Greece issues could trigger a shift in investor sentiment especially if it is combined with a slowdown in the Euro Zone recovery. Greek borrowing costs have more than doubled at the sale of 13-week bills. This prompted Bundesbank President Axel Weber to say that Greece may need more assistance. At this time, investors seem to be looking for a short-term fix to a long-term problem. Another call for financial aid from the European Union could begin to erode confidence in the Euro’s ability to survive. All of this news indicates that traders should continue to look to sell rallies while maintaining a bearish bias for the Euro.


Higher crude oil and gold are helping to give the Canadian Dollar a boost. In addition, traders expect Bank of Canada Governor Mark Carney to signal that the central bank is poised to raise interest rates in the near future. Although the BoC is expected to leave interest rates unchanged at 0.25% at today’s meeting, it is expected to present a more hawkish policy statement. Financial market traders are pricing in a rate hike on June 1 rather than the previous guess of July 1. Traders cite the strong economy and the prospect of further rate hikes as the main reasons why the USD CAD should continue to feel pressure.


The easing of tensions over the SEC/Goldman Sachs fraud lawsuit is encouraging demand for higher yielding assets which is helping to boost the USD JPY. Traders are also pressuring the Yen because of increased optimism that the global economic recovery remains on track. Since late last week, the Dollar appreciated against most majors as traders began to factor in the possibility of a prolonged economic drawdown because of the disruption from the volcano, the possibility of a revaluation of the Yuan and the threat of tougher financial regulations.


Overnight India’s central bank raised interest rates for the second consecutive month to 5.25%. It also ordered banks to set aside more cash in reserves. India is seeking to slow the highest inflation rate among the Group of 20 nations. This move by India brought attention to the Pacific Rim area because it may mean than China may be next in line to raise interest rates.


Both the AUD USD and NZD USD are up this morning. Overnight the Reserve Bank of Australia minutes revealed that policymakers are concerned that a mining boom will fuel inflation. This prompted them to hike interest rates a 5th time in 6 months at its last meeting on April 6th. Based on the minutes, investors now feel a 6th hike will take place at the RBA’s meeting in May.


“The fact that the prospective rise in terms of trade was likely to be noticeably stronger than had been expected was a factor suggesting that it might be prudent not to delay” any further interest rate hikes. This comment from RBA policymakers triggered a sharp rise in the Aussie Dollar. Financial traders also increased the possibility of a rate hike in May from 21% to 33%.


Today’s more hawkish than expected words from the RBA also helped increase speculation that the Reserve Bank of New Zealand is poised to shift to a more hawkish stance at its next policy meeting.





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