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Bank of England Signal That Rate Hikes May Be Over

DailyFX Forex Fundamentals 08-11-04

By Kathy Lien, Chief Strategist

· US Budget Deficit Widens to $396 Billion
· Bank of England Signal That Rate Hikes May Be Over
· Japanese Trade Surplus Narrows More Than Expected


Unsurprisingly, the euro extended yesterday’s losses against the dollar. However, prices have remained in a relatively tight 64-pip trading range indicating the lack of conviction by the market to rally the euro further ahead of tomorrow’s US retail sales report. Although the market is inclined to believe its almighty Chairman, it is doing so cautiously and prefers to wait for substantial evidence in support of the Fed’s more optimistic outlook before extending the dollar’s rally. Consumer spending is the backbone of the US economy and tomorrow’s retail sales report is particularly important because it is the first retail sales report for the third quarter. Retail sales fell –1.1% in the month of June, which is also the second month in the quarter in which there was negative advance retail sales growth. A rebound is certainly expected given the increase in auto sales in the month of July. However, the weekly Redbook sales reports paint a slightly different picture, Redbook sales fell every week in the month of July. This means that the rebound should be weak, at best.


The US budget deficit widened to $396 billion last month. On a monthly basis, the deficit increased by $69.2 billion, more than the market’s forecast of $62.5 billion. Revenues increased 8.8%, while spending increased 15%. More specifically, military costs accounted for the biggest dollar increase in spending. The US’ twin deficits have always been a grave concern that resurfaces as an issue whenever the market is indecisive or confused about the next direction for the dollar. Today’s US Treasury auction received moderate demand - the government needs to continue to sell debt in order to fund the deficit. Aside from retail sales tomorrow, we are also expecting jobless claims for the week ending August 7th, import prices, and business inventories. We have a very busy economic calendar over the next 2 days. Meanwhile, in Switzerland, retail sales increased 6.2% in the month of June after declining -3.5% in May.


In what should not be a significant shock to our readers, the Bank of England signaled that their tightening cycle could be coming to an end. The central bank has raised rates by 125bp since November and recently we have been seeing a lot of mixed data, suggesting that the five rate hikes are finally slowing the economy. We have previously said that the mixed data could very well be a predecessor of slower growth. At the press conference, BoE Governor King said that, “consumption will continue to decelerate in the wake of moderate income growth and a weaker housing market.” He also said that, “the central projection is for a sharp slowing in house-price inflation” and “the committee believes that the risks around the central projection are evenly balanced but they are significant in both directions.” The central bank believes that house price inflation has now “peaked” and they expect “further moderation” going forward. Given that the BoE’s core focus is on the housing market, their comments today suggest that we should only see one or two more rate hikes before the BoE calls it quits. Meanwhile, the labor market continues to improve as the number of unemployed individuals fell by a more than expected 13.7k.


Japan’s trade surplus increased for the 12th consecutive month, while the current account surplus surged 31.9% yoy to a record high of ¥9.64 trillion. However, the increase was less than the market had anticipated on the back of falling exports to the US. Demand from Asia, and in particular China has been very strong. Shipments to Asia increased 20%. Corporate goods prices increased 1.6% yoy, which is the biggest rise in 16 months. Meanwhile, in a report released yesterday by the IMF, they forecasted the Japanese economy to expand by 4.5% this year, matching the growth in the US. The IMF tacked on 1.1% to the original estimates that they released in April. They expect Japan’s stellar growth to slow next year, falling to 2.4% yoy.


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