Foreign Currency Report 22 January 2007

GBP
Sterling ended last week trading at 2-1/2 year highs against the Euro after British retail sales data exceeded expectations.

Sales rose 1.1 percent in December, their fastest monthly rate in 1-1/2 years and above forecasts of 0.5 percent growth, demonstrating shoppers' resilience to Bank of England interest rate rises last year.
Sterling has been buoyant in recent days, hitting a 2-1/2 year high against the euro and 6-week high against the dollar, following the surprise Bank of England rate rise and strong inflation data.

But analysts said further gains in sterling were unlikely in the short-term. "Short sterling futures are discounting two more rate hikes, and sterling is looking overbought -- the data has not been massively strong," said Naeem Wahid, currency strategist at HBOS.

Data from the British Bankers Association showed underlying mortgage lending up 5.8 billion pounds in December, versus 6.7 billion in November.

Bank of England policymakers kept the prospect of higher interest rates on the agenda on Friday.

Monetary Policy Committee member Timothy Besley said policymakers will do whatever it takes to get inflation back on target.

BoE Chief Economist Charles Bean said at a conference in Budapest that inflation may deviate further from its 2 percent target, forcing the Bank of England to write a letter to the government explaning why following date showing annual inflation hit 3 percent in December.

Investors are speculating about further BoE monetary tightening, following recent strong data and three hikes in the past six months.
Analysts are forecasting that MPC members voted 7-2 for the surprise January rate rise. Minutes of that meeting are due on Wednesday, along with the first estimate of fourth quarter growth data.

If two people or more voted for steady rates, sterling could come under a bit of pressure.

There are a number of options to look at when securing currency. With a very strong pound in the market, looking at securing rates in the short to mid term would be extremely prudent.

USD
The price action in the US dollar over the past week suggests that there may no longer be any buyers left in the market. Nearly every piece of US economic data has surprised markets to the upside, highlighting the overall strength of the economy. Improvements have been seen everywhere from housing to manufacturing to the labour market, consumer spending and inflation. According to the University of Michigan Consumer confidence report, optimism hit a 3 year high in the month of January. Comments from Federal Reserve Presidents Hoenig and Bies also continued to confirm the market's general belief that interest rates will remain unchanged throughout the first half of the year. Both Presidents felt that improvements in the economy should keep inflation risks skewed to the upside. All of this should have been very positive for the US dollar, but it wasn't. Except for the Japanese Yen, the US dollar either lost value or remained unchanged against every other major currency. This counterintuitive price action can only be a result of either central bank buying or scepticism about how much longer this dollar rally can last. A quiet data week ahead makes the chance that the US dollar could resume its prior rally even slimmer. The only major piece of data due for release is durable goods on Friday, but there are 2 other reports worth watching. The first is oil. Crude prices are hovering slightly above the key $50 a barrel mark. Should it break below that, we could see oil prices spiral lower as stops get triggered, which would also send the US dollar higher. The second is President Bush. He will be giving his annual State of the Union Address on Wednesday. With comments expected on improvements in the economy, but without a Republican Congress, it will be interesting to see how the subjects of the political and economic landscape going forward are tackled.

EUR
Despite a week of stronger US economic data, the Euro still managed to rally 4 out of the past 5 trading days against the US dollar. Comments from European Central Bank officials have indicated that they could be slowing down their pace of tightening, but traders are now firmly expecting at least one more interest rate hike. Nearly all of the Eurozone's monetary policy members have said that rates still remain low, while inflation may increase back above 2 percent or more this year while growth may be near or above potential, forcing the central bank to act in a 'timely, prompt manner if needed.' The futures market is currently pricing in a 100 percent probability of a March rate hike. Given that the central bank likes to prepare the markets for a move, there would not be such hawkish comments unless the ECB planned to deliver to the markets what they expected. Unlike the US, there are a number of important pieces of data due for release next week. This includes the German IFO report, French Consumer Spending, Business Confidence and Eurozone money supply.