The Bank of England cuts UK interest rates by 25 basis points

The MPC yesterday cut its main interest rates for the first time in two years in an attempt to boost consumer confidence and avoid falling short of its inflation target. The Committee cut rates by 25 basis points to 4.5% in an attempt to bolster spending after a weak first half year.

They did however indicate that another cut in the short term was unlikely, citing a rise in equities prices and a fall in the exchange rate should help to shore up activity.

As a result of better than expected data out of the UK earlier in the week, the market drifted away from fully pricing in a cut in UK rates, and sterling softened slightly after the announcement at noon yesterday.

However a late sell-off of the Dollar saw sterling strengthen breaching the 1.7800 level against the buck, but weakened further against the single currency, as the pound lacked independent direction.

The Dollar slid again on the exchanges yesterday, ahead of today’s key non-farm payrolls data, next week’s FOMC meeting and as pessimism over the Euro continues to diminish as growth prospects strengthen in the Euro-Zone.

The Dollar fell to two month lows versus the Euro as short-term investors unwound long-dollar positions ahead of today’s data release. Analysts expect to see the creation of about 180k new jobs in July.

There were no surprises from the European Central Bank, as they left rates on hold yesterday at 2% for the 26th month.

The Yen weakened across the board yesterday, as opposition to the reform bills continued, sparking fears of a snap election in Japan. A rejection of the bill to privatise the nations postal system, would be considered tantamount to a vote of no confidence. A ‘no’ vote could trigger a knee-jerk selling of the yen.

Elsewhere, European equity markets fell lower yesterday witnessing profit taking ahead of today’s US non-farm payrolls. Wall Street also ended lower yesterday after disappointing retail sales from many US companies. Profit taking also pushed the Nikkei lower.

Euro dominates direction driving dollar down

The Greenback fell sharply across the board yesterday as investors and central banks alike sold the dollar and bought the Euro.

The Saudi Arabian Monetary Authority alone were reported to have bought between €1.5bn & €5bn and sold US Dollars yesterday. This is seen to have been part of their ongoing diversification of dollar denominated oil proceeds.

The initial move was sparked by fundamentals, stronger than expected economic data out of the UK & the Euro-Zone – both regions posted better than expected service sector PMI figures.

As the move gathered pace, EUR/USD broke the key technical level of $1.2250 which triggered stop-loss orders and option expiries alike, exaggerating the move and encouraging traders with long-dollar positions to continue the dollar sell-off.

More generally, the Euro seems to be flavour of the month, investor pessimism over the single currency has begun to fade, as the Euro-Zone’s economic outlook appears more upbeat.

This is in stark contrast to the US, where a slew of positive data has not been able to curb the buck’s slide, investors looking instead at geopolitical factors, the country’s twin deficit and the renewed rally in commodities.

Gold is trading at a four week high of $435.60 per ounce, and oil is at a record high trading at $62.40.

Attention in the market today will be focussed on the Bank of England’s rate decision due for release at 12pm, the ECB’s rate decision 45 minutes later at 12.45pm and the key indicator of the week, July’s non-farm payrolls due out of the US tomorrow at 13.30 BST.

The MPC are widely expected to cut UK interest rates by 25 basis points to 4.5%, and this cut has been factored into the market. However, this will be a close call as inflation in the UK hit the Government’s 2% target in June, and a 25bp cut could reignite the housing market, encouraging further borrowing. This could be reason enough for the MPC to leave rates alone. If we do see a cut, expect sterling to soften slightly as the pound’s interest rate superiority diminishes.

Attention focussed on Central Bank meetings tomorrow

The Greenback was once again on the soft side yesterday, cable traded well through 1.7700 and EUR/USD comfortably broke 1.2200. The buck slid for two days despite a run of reasonably positive US economic data as attention once again focussed on the US twin deficits.

The Dollar has subsequently bounced back as the market focus turns to the US jobs report due out on Friday, and any indication it will offer as to the Fed’s longer term tightening campaign.

Solid US data yesterday raised expectations that the Fed may hike rates to 3.5% as early as next Tuesday, and encouraged flows into the US currency. However general sentiment is that the Federal Reserve will need to lift rates higher than 4% next year to help the Greenback extend its flagging rally.

Improved economic fundamentals in the Eurozone have eroded chances of an ECB rate cut at their meeting tomorrow. Markets will watch with interest, the release of the service sector PMI this morning, it is expected to have edged up to 53.4 in July. Data such as Germany’s IFO reaching 7-month highs and an expected decline in Germany’s unemployment has helped underpin the single currency. July’s service sector PMI is also due out of the UK this morning and is expected to drop slightly to 55.5.

The Bank of England meets tomorrow and is widely expected to cut interest rates by 25 basis points; although this cut has been factored into the market, we could see some sell-off of the pound following the decision as sterling’s interest differential advantages erode. Asian currencies including the Yen rose yesterday, helped by indications that Japanese deflation may finally be coming to an end, increased optimism was reflected in the equity markets.

However there is growing uncertainty over the future of Japans Prime Minister Junichiro Koizumi. The upper house votes this Friday on the postal reform bill. A rejection could trigger a snap election and cause the collapse of Koizumi’s government.

Sterling rises against the Greenback in spite of UK interest rate cut expectations.

The Dollar fell across the board yesterday as markets continued to focus on the US twin deficit. Fears of a further widening of the US external deficit due to Dollar strength were underpinned by an IMF report.

It appears the Greenbacks recent rally has ground to a halt, despite a slew of positive data out of the US. Yesterday’s ISM manufacturing report showed factory growth at a seven-month high, the PMI rose to 56.6. Geopolitical concerns are seen as a further factor in the reverse of the buck’s fortunes.

Further Dollar bearish news came in the form of Russia’s decision to increase the share of Euros in its target currency basket and cut the Dollar’s share.

The single currency found support from strong manufacturing data out of the Eurozone. The purchasing managers index, an indicator of the strength in the economy, showed the industrial sector move from contraction to expansion, rising from 49.9 in June to 50.8 in July.

The Bank of England’s decision to cut interest rates on Thursday seemed increasingly likely following weaker than expected manufacturing data for July. Forecasts expected to see an increase in July to the crucial 50 point level, however the figure came in worse than the previous month at 49.2.

The death of Saudi Arabia’s Kind Fahd, although causing a spike in the price of oil above the $61-a-barrel mark, is not being seen as major cause of concern, as Crown Prince Abdullah has been de facto ruler since Fahd was incapacitated by a stroke in 1995.

Elsewhere S&P 500 rose 0.1%, the Dow Jones fell 0.2% and European markets were largely flat on profit taking.

Slowing economy may force long-awaited cut in UK interest rates

The main focus of attention this week will be on the Bank of England’s interest rate decision on Thursday and non-farm payrolls out of the US on Friday.

The MPC are widely expected to cut rates on Thursday by 0.25% to 4.5%. This is exactly a year after the last move, a quarter percent hike in July 2003, implemented to cool the housing market.

The cut is expected amidst increased evidence of a slowdown in the UK economy. The consumer sector has seen four quarters of weak growth and the manufacturing sector has fallen back into recession. Last month 4 of the 9 members voted for a reduction. A Reuters poll of 47 economists found that 43 believed the Bank of England would cut rates this week.

US non-farm payrolls, due out on Friday, are expected to have risen by a seasonally adjusted 180,000 in July. This figure is in line with the average increase over the last six months and higher than the weak June figure. US data over recent weeks has been strong, allaying fears of an oil-induced soft patch in the US and indeed the global economy. Arguably trader’s dollar bids haven’t been in line with this strong data, suggesting high expectations for the greenback.

In the shorter term, the USD has slipped against the major currencies this morning ahead of ISM manufacturing due out this afternoon, and following remarks from the IMF that the USD may need to weaken further to help correct the country’s current account deficit.

Manufacturing data is also due out of the UK and the Euro-zone today at 09.30 and 09.00 respectively. Both figures are expected to rise.

Elsewhere in the markets, US stocks may fail to extend their recent rally as higher interest rates offset strong second-quarter earnings. In July, both the Dow and the S&P 500 had their best performances since December 2003.

Oil prices have risen more than 50 cents – to above $61 a barrel, a 3 week high, trading on news that King Fahd of Saudi Arabia, the worlds largest oil exporter, was dead.