The US Dollar fell yesterday, losing some of the gains made earlier in the week as a short covering rally fizzled out and US treasury yields fell. Analysts consider dollar selling against the euro and other currencies by reserve managers was forcing the US currency down and that it would remain under selling pressure, especially if the Fed says it will continue to pump money into the market to improve liquidity.

The issue for the US dollar seems to be whether the market believes the Fed will deliver significant quantitative easing over a definitive time period.

In other news out of the US, the durable goods data showed an increase to 3.3% against expectations of 2%. Month on month new home sales also showed an increase in September at 6.6% against expectations of 4.2%.

The market reaction to these figures was muted as markets await the QE2 announcement in November.

Sterling strengthened against the euro and dollar on Thursday after stronger than expected Q3 GDP data cooled speculation of an extension of quantitative easing by the BoE in the near future.

The Pound got a further boost from talk that there is persistent buying interest on UK sovereign bonds from Middle East.

The recent US Dollar weakness has been driven by the markets expectation of a monster bout of Quantative Easing (QE) over the next few months. Judging by current levels analysts have estimated that the market was expecting as much as $1trn in further asset purchases by the Federal Reserve.

However, recent rumblings from the American central bank has begun to indicate  that any further QE will be much smaller in scale, $100 billion or so (the number seems small fry now) and will be implemented over a longer time frame.

Mr Bernanke has already made the analogy between further QE and a golfer with a new putter on the final hole of miniature golf course.

He said that it is better to be conservative and strike the ball less firmly due to the unknown way the ball will react to the new putter.

Yes, I think it’s a rubbish metaphor as well- Little Toot would be better, but that does not change the fact that the market is very short Dollars at the moment and next week’s FOMC may see a spike in the value of the Greenback.

Shorts may rush to cover positions if QE is indeed on a much smaller scale than expected.

It will be interesting to see the reaction of the stock market, recently reacting as though on steroids in anticipation of shock and awe QE, deflates with a whimper or reacts violently as though the legs have been kicked from beneath it.

The UK’s economy grew at 0.8% between July and September official figures show- showing that the economy is recovering faster than expected.It follows 1.2% growth in the second quarter of the year, and is double the 0.4% expected by analysts.

Meanwhile rating agency Standard and Poor’s upgraded its outlook for the UK’s triple-A credit rating.

Chancellor George Osborne called both reports “a vote of confidence in the new government’s economic policies”.

The gross domestic product (GDP) figure released by the Office for National Statistics (ONS) is only a first estimate, and may be revised up or down.

Analysts had expected a slowdown after weak retail sales and housing data.

But the government’s planned cuts in its Spending Review got a stamp of approval from ratings agency Standard & Poor’s, which raised its outlook for the UK’s triple-A rating back to “stable” from “negative”.

“In our opinion, the decisions reached by the United Kingdom coalition government in its 2010 Spending Review reduce risks to the government’s implementation of its June 2010 fiscal consolidation programme,” the company said in a statement.

The Treasury will take heart from the robust growth performance even with the first spending cuts beginning to bite.

Manufacturing and services both kept up their momentum.

The recovering construction industry contributed almost a third of the total GDP growth for the quarter. The building industry has been dealing with a backlog of work that had been postponed from the beginning of the year due to bad weather.

However, the latest data suggests that the recovery may be becoming slightly broader-based.

Manufacturing slowed to 0.6% from 1.0% the previous quarter, but was still ahead of predictions.

Service industries also held steady at 0.6% growth, with the transport, storage and communications sub-sector returning to growth.

The Pound jumped following the news, which lowered expectations that the Bank of England will engage in further quantitative easing in the near future.

The Pound rose one cent against the dollar, to $1.585, immediately following the data release.

Late in the day yesterday the US Treasury sold $10 billion of Inflation Protected Securities at a negative yield for the first time in history. Should the Fed be successful in fuelling inflation with these tools, it may persuade investors to buy dollar denominated assets and in due course prove to be positive for the currency.

The National Association of Realtors in the US said existing home sales increased 10% in September versus the 4.1% anticipation, but subdued prices and ongoing analysis over the foreclosure practices of America’s largest mortgage lenders make it likely the housing market is still dragging its heels.

The euro had a pretty quiet session yesterday proving not to be particularly robust.

The S&P credit agency suggested a strong German economy may force ECB to hike rates sooner rather then later and ECB Weber said discussion for stimulus exit was on the table for Q1 2011.

This morning French Consumer confidence unexpectedly rose for a fourth month in October to the highest level since Marxh as employment prospects and corporate earnings improved.Sweden’s central bank raised its benchmark repo rate by 0.25% for a third time since July while policy makers said the prospect for a sluggish global recovery suggest further tightening plans should be scaled back.

Remarks from MPC member Paul Tucker yesterday concerning the ‘reasonably strong’ headwinds that the UK economy is facing suggested that whilst some in the committee may be leaning towards more QE, those opposed to further measures are becoming more vocal, but given the current level of inflation, there is concern about the effects a new round of easing may have on the economy further down the line.

The gap between what is promised before a G20 finance meeting and what is announced afterwards seems to be growing.The theme at this meeting was, unsurprisingly, currencies and specifically how to stop nations engaging in beggar-thy-neighbour competitive exchange rate devaluations, to keep exports cheap in the face to falling domestic demand.

This path would be disastrous for world trade and global growth in general, which need stability to allow goods, services and capital to flow freely from country to country.

What was agreed by the G20 was that the scenario above would not be allowed to happen, but the agreement stopped short of actual commitment.

The US proposed that export surpluses be capped at 4% of GDP, a sensible idea, but the current global imbalances mean that is about as likely to happen as the G20 coming up with a concrete commitment on anything.

Although it is disappointing that nothing solid was agreed, the news is generally positive and has helped stocks to gain in nearly trading and the Dollar and Euro to gain against the Pound.

The US seems satisfied that China will allow the Yuan to appreciate and it now looks unlikely that the punitive import taxes the US were threatening to slap on Chinese exports will go ahead.

Sterling has opened up the week on the back foot as continued selling pressure stemming from last weeks Public Spending Review work through the system.

The market is waiting to see if the Bank of England is seriously contemplating another round of QE and tomorrows GDP figure will probably give us a good indication of the Banks next move.

The forecast is for 0.4% on a quarterly basis but after the previous retail sales figure disappointed, we are bracing for a number showing a further weakening in growth.

A day of little action yesterday with money market’s attention being focused on the G20 meeting in South Korea. The Dollar did soften during the European trading day, but not on anything tangible – more on speculation of an impasse on the G20 discussions rather than fundamentals or economic news.

Sterling did not fare well however with continued concern over the UK economic outlook.

Buying the Greenback on an assumption that the G20 participants will be able to come to any agreement on currencies’ values or global economic rebalancing looks a very dangerous strategy and therefore I expect Euro/Dollar to ease back up into the high 1.39s before London’s close.

Remarks made by Tim Geithner, supporting a letter from the US delegation sent to the other nineteen G20 members, gave risk currencies a bit of a bid feel.

He said that G20 countries should cap their external imbalances at a particular, though unspecified, share of GDP.

It appears that the aim of any such measure would be to force export dependent economies to focus instead on stimulating domestic demand, and this should in theory reduce local objections to currency appreciation.

The US, however, are encountering strong opposition from other nations, specifically those in the Far East towards who, the accusative finger of the US Treasury tends to point.

Lack of progress at the G20 meeting will undoubtedly mean a continuation of Quantitative Easing driven markets and a longer term change of sentiment towards the Dollar would only emerge if/when US data begins to improve or it was deemed that the whole concept of QE was deemed ineffective.

As Wise Money expected the Bank of England’s release yesterday of the MPC minutes revealled that there was a three way split amongst it’s members.
Adam Posen showed that he argued for, and also voted for, an increase of £50 billion in the amount of QE in the system.

This kind of addition would equal a 25% increase in the holding of gilts by the BoE – a sizeable sum.

Naturally, the vote for no change outweighed Posen’s submission and also Andrew Sentence’s regular demand for a withdrawal of liquidity on perceived inflationary pressures.

Sterling didn’t react too well to the outcome – nothing serious but just looked a little vulnerable.

The Budget cut provided little additional information – lots of numbers and political jargon but nothing unexpected for the money markets to react to.

The more prevalent remarks came from the Institute of Fiscal Studies within a report released overnight.

In it they questioned whether the Government’s UK growth projections were overly optimistic and that there was a possibility that the £ 80 billion – odd of cuts might not prove to be enough.

Sterling reacted badly to this forecast, and fell to a 6-month low against the Euro.

Overseas investors are going to need verification that the behaviour taken would produce results before they get their assurance in the currency back. This will leave Sterling prone to continued downside pressure in the short term.

For global currencies, and ahead of this weekend’s G20 meeting in South Korea, two events have provide this morning’s interest. An interview with the US Treasury Secretary, Tim Geithner, reported in today’s Wall St Journal proved interesting reading.

He emphasised that the US had not embarked upon a policy of devaluing the US Dollar and that the strong dollar was still vital for global stability and recovery and that the major currencies values were roughly in line.

He did however divide countries into 3 groups and pointedly entitled the first, which included China, as those whose currencies were “undervalued by any measure”.

He berated the emerging market countries for not allowing market forces to set currency values (especially China) and stated that they all had a role to play.

He added that, “If China knew that if it moved more rapidly, other emerging markets would move with them, it would be easier for them to move.” This could all make G20 a bit lively with the US seemingly trying to create a them and us situation with the us being the ‘good guys’ and the them being cast as the villains.

Sterling may have a volatile day as the Pound gets pushed around by the release of the MPC minutes from the last meeting and the long awaited public spending review, which will be presented by Chancellor George Osborne at lunch time. Right on cue, the former has just been released, showing a MPC member (surprise surprise it was Adam Posen) was the only pushing for further stimulus measures (extra QE) and sending Sterling down 30 pips in quick time.

We finally have 3 different views on the committee, 7 voted for no change and Andrew Sentence again voted for a rate rise. We’ve also just seen worse than forecast public finance and public sector net borrowing data no doubt adding to the negative Sterling sentiment.

The Public Spending Review will detail where the axe will fall, right across government departments.

If there are no surprises and the cuts are in line with the plans announced in the Budget, then most of details should already be priced into the market.

However, we are not ruling out a bolt from the blue by Mr Osborne, as this is why the market will be very choppy right for the majority of today.

The surprise interest rate increase by the Chinese helped the safe haven Dollar to gain slightly across the board.

The move can be seen as part of the Chinese government efforts in unwinding the stimulus measures put in place during the financial crisis and also can be seen in the context of the on going ‘currency wars’ as a olive branch to the US.

Eventually the rate rise should see further appreciation of the Yuan against the Dollar.

Sterling weakened against both the euro and the dollar yesterday ahead of Chancellor George Osborne announcing details of the coalition government’s spending cuts to tackle Britain’s record budget deficit.The Pound fell against 13 of its 16 most-traded peers as some investors speculated the Chancellor’s cuts will not reduce the deficit at the required pace.

With Bank of England policy makers split on whether to raise, maintain or withdraw stimulus, former MPC member Blanchflower expressed concerns of a renewed recession during an interview yesterday.

He stated that the UK is “desperately in danger of a double dip and the last thing you need to do in a recession is make things worse”.

He went on to suggest that stimulus expansion appears to be George Osborne’s only backup plan to avert the risks associated with the biggest budget cuts in UK history, but “quantitative easing just doesn’t act fast enough” to avert the risks of a contracting economy.

Watch for more GB Pound pressure ahead of the Spending Review tomorrow.

Despite posting disappointing industrial production numbers, the US Dollar continued to gain since Friday’s close, adding further weight to the argument that the market has priced in too much QE2 and the long dollar selling spree has created a market short of USD.

Overnight comments from Treasury Secretary Geithner helped the Greenback recover further ground.

Geithner said “No country can devalue its way to prosperity and that the US will not engage in such practice”.

He added that “He does not see a time in our lifetime when the dollar will cease to be the world’s key reserve currency”. There seems to be more room for the dollar to pull back particularly against the euro as expectations for monetary tightening by the European Central Bank appear excessive.

The interest rate market is pricing in a rate hike by the ECB in Q3 2011 suggesting that investors haven’t fully digested the slowdown in Europe.

The US Dollar made ground over night after better than expected manufacturing data and an unexpected rise in retail sales on Friday. This  has reduced concerns that falling consumer spending may weigh heavy on the economic recovery.

But the US Treasury’s budget shortfall remained in the trillions and the University of Michigan consumer confidence index fell to 67.9 points. Consistent high levels of unemployment (unchanged at 9.6% in September) and increasing initial job claims numbers are contributing to downside pressure.

Overall, the Dollar has spent the last 6 weeks sliding lower on the opinion that QE2 is required in order to firm up the declining US economy.

Ben Bernanke’s explanation on Friday indicated that additional monetary stimulus may be necessary, stating “there would appear… all else being equal… to be a case for further action” in order to “promote our dual objectives of maximum employment and price stability” yet gave no indication on how much, or when.

The USD pared losses and finished the day higher, which suggests the contrast between expectation and reality that can exist in currency markets and questions how much easing is already factored into the price. This in turn could make the Dollar susceptible to sharp rebounds.

The market will now seek direction from the FOMC meeting on November 3rd.

The Pound will be in centre stage this week, with markets watching to see what areas of the economy will be most affected by Osborne unveiling the details of the largest budget cuts in UK history and the release of the minutes from the Bank of England meeting (6-7 Oct) both on Wednesday.

We’ve already seen reports from the Centre for Economics and Business (CEBR) suggesting the Bank of England will expand its stimulus program by £100bn to boost the economy as growth begins to contract and austerity measures begin to curb spending.

They also stated that the central bank will keep its benchmark interest rate at a record low of 0.5% until at least “late” 2012

Expect some more significant volatility in currency markets over the week as central banks look to talk their recovery prospects up and their currencies down.