WISE MONEY

Sterling has just received a welcome boost after the release of positive retail sales figures.Data showed a 0.7% increase month-on-month & 1.3% yoy, the highest monthly figure since April 2008.

The ONS suggested the World Cup boosted consumption of electrical goods, which after England’s performance should see a double whammy when people look to replace the TV’s thrown out of the window after the Germany game.

Bank of England minutes released showed a 7-1 vote in favour on keeping interest rates on hold, with Andrew Sentence, the only dissenter, voting for a rate rise. More interestingly, the minutes showed discussion of an extension to the asset purchase scheme if, as expected, the economic outlook continued to deteriorate.

Sterling continues its recent volatility in light of the comments & also rumour circulating yesterday that the bank has reopened dollar swap lines and low liquidity in the market exaggerates moves.

The Euro continues to tread water ahead of the Stress test results. There is increasing uncertainty around the release of the results, the planned announcement is today at 4.30pm.

Strange that an exercise in reducing uncertainty and restoring credibility is actually having the opposite effect, and that is feeding though to the Euro which now trades lower against both Sterling and the Dollar.

The perceived safe haven of the Swiss Franc has also hit the headlines as the SNB announced a huge FX loss following large bouts of currency intervention earlier in the year. The continuing strength of the Swissy will be a real headache for the central bank as it fights to remain out of a potential deflationary spiral brewing in the Eurozone.

Last night Ben Bernanke, Chairman of the Federal Reserve, delivered his twice yearly report to Congress where he outlined their outlook on the US economy.
Due to the oblique nature of Central Bank parlance, Mr Bernanke’s speech was closely watched for any indication, however vague, that the Fed thinks the economic recovery in the US is not proceeding the pace originally thought.

He duly obliged, saying that the outlook was “unusually uncertain” and stressing again that persistently high unemployment remains a real problem and is likely to remain so for an extended period.

The dovish tone and increasingly cautious outlook naturally led to a reduction in risk appetite and the corresponding sell off in US equities and rise in the Dollar.

Cable had a volatile days trading yesterday, just before 8am we saw a huge Sterling sell, dropping from 1.5290 to 1.5168 in a minute before recovering after reports of a fat finger or algorithmic trading problem at a bank in the Netherlands.

Whatever happened, we are sure someone is seeking alternative employment this morning.

This week is all about the euro and the approaching stress test results which will offer much needed feedback on the health of European banks.
The euro has experienced a significant turn of fortune from its June 4 and half low against the USD gaining over 10 cents to test the 1.30 level.

One reason that the euro has gained is simply that the market was significantly over short in the euro and naturally a lot of these short investors paired their positions leading to a short squeeze higher.

In addition some comfort has come back into the euro approaching Fridays stress test results as comments in the run up from members of the IMF and the ECB have been bullish – we will see!

Recent gains have led to EUR/USD testing the 1.30 level and GBP/EUR falling back into 1.17 territory. The results are due out from 5pm GMT on Friday- good feedback should push EUR/USD over 1.30.

The Euro rose significantly yesterday rising up to 1.2991 against the dollar and breaking, although briefly 1.30, a ten week high.The gains were owed to more weak data from the US where home-builder sentiment fell more than expected in July to the lowest level in over a year and comments from many of the EU countries stating their most important banks had passed the stress tests.

Germany, whose sources said Deutsche Bank and Commerzbank passed the tests look set to see Hypo Real Estate, a small nationalised mortgage lender fail, and it could be the first of many banks who specify in that market.

With the housing market across Europe still struggling, banks who exclusively work in that sector could have overly exposed balance sheets and be the next to require a takeover or even a bailout.

The Euro has also gained massively against Sterling falling well back from the high of 1.2380 3 weeks ago to 1.1750.

The BoE will be releasing the MPC Meeting minutes from the July rate decision tomorrow where we will find out more details to the divide growing in the committee.

Record price cutting in the Summer sales on the high street and falling petrol sales helped to push down inflation to its lowest rate since December.
The annual Consumer Prices Index inflation rate fell from 3.4 per cent to 3.2 per cent in June, the Office for National Statistics said.

Clothing and footwear prices fell by 2.1 per cent – the biggest reduction seen in June since the ONS began collecting monthly figures 14 years ago.

Petrol prices fell by an average 2.6p a litre to 117.9p – in contrast with a 4.4p hike a year earlier – dragging down the rate of inflation.

The ONS said clothing sales were more widespread this year, particularly for categories such as womenswear.

Offsetting this were other factors such as the soaring cost of air fares – ticket prices to South Africa doubled for the World Cup – as well as higher insurance premiums.

The figures also showed a rise in “core” inflation – excluding volatile factors such as food and petrol – over the month from 2.9 per cent to 3.1 per cent.

The CPI rate of inflation remains well above the Monetary Policy Committee’s 2 per cent target and has stayed at 3 per cent or higher throughout this year.

The Bank has already predicted that CPI will gradually fall back later this year as the economic slack built up by a record recession drags down prices.

The committee has left monetary policy unchanged since last November, with interest rates at a record low of 0.5 per cent.

The retail price inflation measure – which includes mortgages costs – fell less than expected to 5 per cent from 5.1 per cent.

Factory gate prices from manufacturers fell last month for the first time since November 2008.

An unnamed bank or banks had lent 380 tonnes of gold to the Bank of International Settlements in return for foreign currencies causing widespread surprise and confusion.
The news that a mystery bank has just pawned the family jewels gave traders a jolt – nervous about the sudden transfer of almost 20pc of the world’s annual gold production and the possibility of a sell-off.

In a tiny footnote in its annual report, the BIS disclosed its unusually large holding of gold, compared with none the year before. The disclosure was a large factor in the correction of the gold price this week, which fell below $1,200 for the first time in more than a month.

Concerns hinged on whether the BIS could potentially sell on this vast cache of bullion in the event of a default, flooding the market with liquidity.

It appears to have raised $14bn for whoever’s been doing the swapping – small fry on the currency markets, but serious liquidity in the gold market.

Denominated in euros, gold has fallen 8pc since the beginning of the month and is now trading at a seven-week low of €937 per troy ounce.

The big gold exchange traded funds (ETFs) – having peaked at record inflows in May – have also been showing net outflows over the past few days.

Meanwhile, economists and gold market-watchers were determined to hunt down which bank is short of cash – curious about who is using their stash of precious metal for what looks suspiciously like a secret bailout.

At first it looked like the BIS was swapping gold with a troubled central bank. After all, the institution is the central bankers’ bank and its purpose to conduct transactions with national monetary authorities.

Central banks in the troubled southern zone of Europe were considered the most likely perpetrators.

According to the World Gold Council, central banks in Greece, Spain and Portugal held 112.2, 281.6 and 382.5 tons of gold respectively in June – leading analysts to point fingers at Portugal, or a combination of the three.

The only other potential monetary authorities with enough gold as the US, China, Switzerland, Japan, Russia, India and Taiwan – and the International Monetary Fund.

This led to musings that the counterparty was the IMF, making sense because the lender of last resort is historically prone to cash shortages and has been quietly selling off gold in the first half of the year.

Renowned gold expert Jim Sinclair adopted this explanation. The panic came when people mistook a lease for a swap, he argues. Far from being a big release of gold into the market, it is simply a commercial arrangement between the IMF and BIS with a favourable rate of interest paid for the foreign currency.

“Gold swaps are usually undertaken by monetary authorities,” he writes on his industry blog, JSMineSet. “The gold is exchanged for foreign exchange deposits with an agreement that the transaction be unwound at a future time at an agreed price.

“The IMF will pay interest on the foreign exchange received. Historically swaps occur when entities like the IMF have a need for foreign exchange, but do not wish to sell the gold. In this case, gold is a leveraging device for needed currency to meet requirements.

“The many reports that characterise the large IMF gold swap as a sale of gold into the markets do not understand the difference between a swap and a lease.”

However, the day after original reports about the swaps, BIS emailed a statement saying that the swaps had not been conducted with monetary authorities but purely with commercial banks.

This did nothing to quell the sense of mystery surrounding the deal or deals. It is almost inconceivable that a single commercial bank could have accumulated so much gold alone. And cynics have suggested that the whole affair still looks like a secretive European bailout that a single country wants to keep quiet.

In this case, one or more of the so-called bullion banks – which act as wholesale market-makers and include Goldman Sachs, Deutsche Bank, JP Morgan, HSBC, Barclays, UBS, Societe Generale, Mitsui and the Bank of Nova Scotia – would have agreed to act on behalf of a monetary authority.

The UK’s Consumer Price Inflation rose by 3.2% year on year in June 2010 compared to 3.4% in May, more than the 3.1% average forecast by analysts.

The widely used Retail Price Inflation decelerated to 5.0% in June compared to 5.1% in May. RPI-X also slowed from 5.1% in May to 5.0% in June. However, core inflation accelerated from 2.9% in May to 3.1% in June, which matched the highest reading since 1997.

According to the Office for National Statistics, the biggest downward pressure to CPI inflation between May and June came from falling energy (petrol and diesel) prices. Another significant downward contribution came from clothing and footwear, where prices fell due to the June sales season.

The latest inflation data will boost the case by Andrew Sentance who is the sole member of the MPC who is looking for a gradual interest rate rise and said the path to economic recovery could be uneven but that did not equate to a risk of a double-dip recession. “I favour a gradual rise in Bank Rate which would be aimed to avoid destabilising confidence through a sudden lurch in policy.”

Sterling reacted well against the US Dollar and moved up to above the 1.52 levels at the close of play from opening at 1.4996.

In European news yesterday, the rating agency Moody’s downgraded Portugal’s debt rating by two notches to A1 from its previous AA2 rating, with a stable outlook. Moody’s explained the downgrade with the ongoing deterioration in the debt ratio as well as the dim medium-term growth outlook.

Markets showed little reaction to the news, probably because Moody’s initially placed Portugal on credit watch in May 2010.

The euro held steady against the dollar after a smooth Greek Treasury bill auction eased some concerns about Europe’s debt crisis, this helped take the sting out of Portugal’s expected credit rating downgrade and disappointing German Zew index.

Sterling weakened yesterday after the S&P said it was maintaining its negative outlook on UK’s AAA credit rating. Data released from the UK included a survey by GfK, which showed 58% of U.K. households expect economic conditions to deteriorate further, with nearly two fifths of the respondents looking to cut back on consumption.

In addition, the final Q1 GDP reading showed economic activity expanded 0.3% from the last three-months of 2009, which was largely in-line with the initial forecast.

However, the growth rate slipped 0.2% from the previous year to mark the slowest pace of contraction since the third quarter of 2008.

Comments from the BoE’s Posen that a continued UK recovery can not be guaranteed also weighed on the currency.

The euro consolidated well below two month peaks against the US Dollar as investors were cautious about the single currency ahead of Greece’s return to capital markets for the first time since late April.

This along with Moody’s cut in Portugal’s rating to A1 with a stable outlook is going to continue to weigh on the euro in the short term and doesn’t bode well ahead of the bank stress test results due next week.

The euro hit a two month high against the US Dollar before running into large selling resistance and falling back towards 1.25. Although German manufacturers posted some impressive sales figures at the end of last week and boosted confidence in the continuing Eurozone economic recovery, fears over manufacturing and unemployment data in periphery member nations is swamping any and all positive news from Germany.

Added to the muted response to the Stress test methodology there is enough news around the keep the Euro suppressed for the next few days.

Sterling fell below the key 1.50 level over the weekend as fears over the UK economic recovery remerged. The IMF’s warning that spending cuts and tax increases announced by the coalition Government will reduce future growth levels has pushed the pound lower against the Dollar and Euro, but the key driver of the Sterling sell off seems to be technical.

Failure to break through the 1.5260 level signalled to traders to realise profits, sending the Pound lower.

We will get a clearer picture of the current economic climate in the UK this week, with the release of the delayed GDP figures and inflation and unemployment data.

The Bank of England has kept UK interest rates on hold at a record low of 0.5% for the 16th consecutive month and the European Central Bank (ECB) has held eurozone interest rates at a record low of 1% for the 14th month running.
The banks have kept rates low to try and stimulate the economies following the global economic downturn.

Many analysts argue rates need to stay low as governments are cutting back on spending- which undermines growth.

The Bank of England’s Monetary Policy Committee (MPC) also decided not to inject any more money into the economy under its policy of quantitative easing (QE).

The decision had been expected but calls have been growing for an increase in rates to curb inflation.

The National Institute of Economic and Social Research (Niesr) estimated that the economy grew by 0.7% in the three months to the end of June, marking a slowdown from the 0.9% expansion seen in the three months to May.

The minutes of July’s meeting, which will reveal how MPC members voted, will be released in two weeks’ time.

Explaining the ECB’s decision to keep rates on hold, president Jean-Claude Trichet said the eurozone’s economic recovery continued in the first half of the year, adding “we expect the area’s economy to grow at a moderate and still uneven pace, in an environment of high uncertainty”.

The eurozone economy has been in the international spotlight in recent months, with concerns about high government debt levels hitting global stock markets and threatening to derail the economic recovery.

In recent weeks, attention has turned to bank debt, with investors eagerly awaiting the results of stress tests designed to see how well equipped banks are to cope with future financial crises.

Mr Trichet said the tests should “build confidence” in markets as investors learnt how exposed banks were to bad debt. Transparency, he said, would be beneficial.

The results of these tests are due to be published on 23 July.