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UK Expected To Keep Interest Rates On Hold Tomorrow at 4.75%

Daily Forex Fundamentals 09-08-04

By Kathy Lien, Chief Strategist of

·Dollar Tanks As Greenspan Warns About Federal Deficit and Softening Inflation
·UK Expected To Keep Interest Rates On Hold Tomorrow at 4.75%
·Bank of Canada Raises Interest Rates By Quarter Point to 2.25%


The euro skyrocketed as Greenspan warned the world of falling core inflation and the troubling outlook for the fiscal deficit. Even though Greenspan said that the “economic expansion has regained some traction” and that “the fundamentals of the US economy remain strong,” the market was looking for a much more optimistic report. According to Greenspan, the outlook for oil remains uncertain, and if it were not for oil, he would be “very optimistic.” We venture to say that if it were not for oil, the global economy would be in much better shape than it is now. Greenspan’s more dovish comments have pushed us right back into the 1.1950-1.2450 trading range in the euro. The markets have thrown around both bulls and bears in recent weeks with gyrating economic data and unclear comments from Fed officials. Greenspan stuck to his optimistic outlook when payrolls were declining and oil prices rising but, is now more dovish / cautious with payrolls rebounding and oil prices receding. His comments today however though do not change the expectation for a rate hike later this month. Today’s comments only suggests that the Fed will proceed ahead with their measured pace of tightening.


After the tremendous sell off following Greenspan’s more dovish comments, the lack of new information in the Fed’s Beige Book report resulted in a lack of reaction in the dollar. According to the Beige Book, the current conditions of the economy are fairly balanced, with no evidence that draws up incredible excitement or disappointment. Retail sales were weak, the housing market is “cooling,” while capital spending remains strong and job gains continuing, albeit unevenly. Consumer prices were flat to modestly higher. This lack of exhilaration in our tone is reflective of the lack of confidence we have on what we call the second round economic rebound. Although we believe that the upwardly revised 73k job growth reported in July is probably the worse that we will see in the pullback on payrolls, the most recent report from the outplacement firm Challenger, Gray & Christmas leaves us slightly more skeptical. The firm reported a 6.6% increase in layoffs. Meanwhile in Switzerland, SNB Directorate Hildebrand said that oil costs are not likely to hurt medium term price stability and will remain committed to maintaining stable prices, “at all costs.” These last few words by the SNB signals their willingness to increase interest rates even as early as next week.


We are finally seeing a day of respectable gains for the British pound with the dollar tumbling against all of the majors. The Bank of England is expected to announce their decision to keep rates unchanged tomorrow at 4.75% after having raised rates by 125bp since November of 2003. The pound has benefited significantly throughout the fourth quarter of last year and first quarter of this year as a result of these rate hikes. With the gradual slowdown in the housing market, retail sales and the manufacturing sector, we are finally seeing evidence that the monetary policy committee has been successful in preventing a steep decline in growth. Only one more rate hike at best is expected from the BoE, which has pretty much been priced into the market. Unless the central bank surprises with a rate hike or diverges from their newly adopted gradual tightening mantra, the pound's higher relative interest rates should have a falling importance for the currency. On a side note, Prime Minister Blair is expected to overhaul his Cabinet by the end of the week. Although this does not have a direct impact on the currency market, the political uncertainty will certainly not be positive for the country or the pound.


The Japanese yen extended its gains against the dollar for the third consecutive trading session. The yen is expected to remain firm ahead of tomorrow night’s (23:50 GMT) second quarter GDP report. The strong capital spending report released earlier this week has bolstered optimism for a high revision. The Eco Watchers survey of current and future economic conditions deteriorated in the month of August as various economic indicators pointed to slightly slower growth. Last week, industrial production, household spending and small business confidence were all weaker than expected.


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