Foreign Currency Report – 20th September 2007

Sterling

Sterling hit a one-year low against a basket of currencies for a third day yesterday, with investors saying the latest Bank of England (BoE) minutes left the door open for a possible rate cut in coming months. The BoE voted unanimously to leave rates on hold in September, adding that upside pressures to inflation have abated and that the outlook has become more uncertain.

The tone of the minutes confirmed market expectations that interest rates have peaked at the current 5.75 percent and may well be cut. These expectations have been fuelled by turmoil in financial markets, weak UK house price data, as well as news that mortgage lender Northern Rock amongst others had fallen victim to the credit market squeeze sparked by defaults on U.S. subprime mortgages. Some analysts said that a hefty 50 basis point interest rate cut from the U.S. Federal Reserve on Tuesday made it more likely that the BoE would also loosen monetary policy in coming months.

Sterling got some respite from the session lows in the afternoon as the BoE offered to inject 10 billion pounds into the money markets in a bid to bring down three-month interest rates, and said it would let banks use a wider range of collateral than is usually allowed. The move helped calm uncertainty about the impact of the recent credit market squeeze on the UK's financial sector.

Today sees the release of UK retail sales for August and the CBI September industrial trends survey. If this data fails to give Sterling an added boost then it will likely be the case that we see Sterling lose further ground today.

US Dollar

Financial markets have risen sharply as they take into account the US Federal Reserve interest rate cut on Tuesday from 5.25% to 4.75%. Analysts had expected the first cut in four years however the 50 basis points was perhaps slightly more than expected. The cut had been put in to prevent a housing market downturn and the credit crunch from denting the economy

Overall US consumer prices fell 0.1 pct last month, in line with expectations. It is the first time it has been in negative territory since Oct 2006. Core prices rose 0.2 pct in August, also in line with expectations. Also out yesterday were figures which highlighted that US housing starts slumped to a 12-year low. This economic data therefore supports the view that the Fed cut of 50 basis points was not only justified but also that another 25 basis points cut may be needed as early as October.

Euro

The Euro has been struggling to find any obvious direction against its major counterparts with very little data due for release for the remainder of the week. In fact German producer prices were the only piece of meaningful economic data on the Eurozone calendar yesterday and that was right in line with expectations.

This has left the Euro now trading at a very important contention point against the US dollar.It is struggling to make a new all-time high which suggests that there are a lot of option barriers. This means there are just as many traders preventing a break as there are ones hoping for one. Given the continued deterioration in US fundamentals and the stability of Eurozone economic data, there is still good reason to believe that a break of 1.40 is inevitable.ECB President Jean Claude Trichet is due to speak today and any unexpected comments could trigger a sharp rally higher. If Trichet
suggests that the ECB may well resume tightening once market turmoil has abated then expect further Euro strength in the weeks to come.