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Tuesday May 8, 2007 - 21:40:40 GMT -

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Forex - British Pound Could Bounce on BRC Retail Sales and Nationwide Consumer Confidence

DailyFX Fundamentals 05-08-07

By Kathy Lien, Chief Strategist of

• Dollar Rallies into Federal Reserve FOMC Policy Announcement
• Euro: Prospect of an ECB Rate Hike Could Limit Losses in the EUR/USD
• British Pound Could Bounce on BRC Retail Sales and Nationwide Consumer Confidence

Dollar Rallies into Federal Reserve FOMC Policy Announcement

With the Federal Reserve monetary policy meeting scheduled for tomorrow, currency traders are either buying up dollars against the Euro and British pound or squaring up shorts ahead of the rate decision. Even though we think that growth indicators warrant a more neutral FOMC statement, inflation pressures will prevent Team Bernanke from making any drastic changes to the language. Our special FOMC outlook on contains a full look into how economic data has changed since the last meeting as well as the key phrases to look for in the statement. The Federal Reserve has not changed interest rates since June 2006 and the futures curve is not pricing in a rate cut until the end of the year. The tug of war between inflation and growth at a time when average gasoline prices are at a record high gives the Fed little room to alter the FOMC statement. Keeping interest rates steady and the statement unchanged will be taken positively by the foreign exchange market, which could lead to a resumption of the uptrend in USD/JPY. We expect the dollar to see more pronounced strength against the Yen than the Euro in reaction to any dollar positive news due to the benefit of carry. Do not forget that the European Central Bank has a meeting on Thursday. They are still on track to raise interest rates in June which means that Euro traders may be hesitant of initiating significant Euro shorts ahead of the meeting. Japan on the other hand continues to sit on their hands. In the event of a surprisingly neutral or dovish statement, we could see the EUR/USD race back towards its all-time highs. Being short USD/JPY may cost too much in daily interest for traders to sell the pair aggressively. Therefore a disappointment by the Fed and the prospects of higher rates in the Eurozone and in the UK could lead to strong rallies in both the Euro and the British pound. The only pieces of US data released today were wholesale inventories and sales. Inventories fell short of expectations, but sales were exceptionally robust.

Euro: Prospect of an ECB Rate Hike Could Limit Losses in the EUR/USD

The Euro tanked today as industrial production failed to live up to the strong factory orders reported yesterday. Annualized growth remained unchanged at 7.7 percent, which compares to the market’s 8.2 percent forecast. The sell-off in the Euro began as soon as the European market opened, which means that London traders did the bulk of the selling. It is important to realize that the EUR/USD is only a little more than a 100 pips off its high which illustrates the market’s hesitancy to take the Euro much lower before the Federal Reserve and European Central bank meetings. Traders fully expect the ECB President to signal that rates will be increased in June. When he wants to signal a rate hike at the next meeting, he usually reintroduces the word “vigilant” into his vocabulary. With no US data due for release tomorrow besides the FOMC rate decision and the Eurozone calendar only containing German trade data, the EUR/USD could consolidate.

British Pound Could Bounce on BRC Retail Sales and Nationwide Consumer Confidence

The British pound weakened today with no UK economic releases to alleviate the pain. However, tonight is a different story as the market awaits a handful of announcements ahead of the Bank of England rate decision later this week. Expected later tonight, both BRC retail sales and Nationwide consumer confidence figures are estimated to revive the recently downtrodden sterling. Although there are no expectations for the retail sales report, sentiment is high that the survey will repeat the 6.2 percent rise seen last month. Consumer confidence is also expected to advance. Both reports will set the underlying currency up well heading into Thursday's rate decision. The question now remains, will speculators be handed another surprise this time around? The Bank of England, a central bank known for catching the market off guard, is expected to raise rates by 25 bp. There is a minority favoring a 50bp rate hike and another group favoring unchanged rates. Either way, with volatility as low as it has been the decision may have more impact than some traders are anticipating.

Yen Crosses Rebound as Dow Reverses Intraday Losses

The Japanese Yen is stronger across the board against every major currency except for the Australian dollar. With the Dow Jones Industrial Average down as much as 75 points intraday, the yen crosses struggled to stay afloat. Even though the US stock market index reversed course to end the trading session unchanged, the Yen crosses only managed to see shallow rallies. We have finally seen the US dollar take charge and dictate market price action once again. The strength of the US dollar against currencies like the Euro, Swiss Franc and British pound played a major role in preventing EUR/JPY, CHF/JPY and GBP/JPY from ending in positive territory, like the Dow. Japanese leading indicators are due for release tonight. The recent weakness of the Yen should have helped to boost overall economic activity.

Australian Dollar Surges after Strong Retail Sales Report

The Australian and New Zealand dollars are sharply higher against thanks to a much stronger than expected Australian retail sales number. Consumer spending posted the third straight increase as the strength of the Australian dollar puts a fire sale on imported goods. Even though building permits were much weaker, the market is putting far more weight on the retail sales number. The Australian government also announced that they will cut taxes before the election this year, which may trigger nice surge in growth. Australian house prices are due for release tonight. The market is expecting a firm number. New Zealand unfortunately is not seeing the same positive indications for growth. In fact, the IMF warned overnight that GDP growth could actually remain below potential for the next 3 years. The kiwi is up today only because the Aussie is up. Meanwhile the Canadian dollar gave back a part of yesterday’s gains after a softer housing starts report. The building permits number released yesterday was for the month of March while today’s housing starts is for the month of April. This suggests that robust growth in Canada may finally be coming to an end.


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