WISE MONEY

The highlight overnight was the release of the minutes from the August 10th Federal Reserve Open Market Committee meeting. Some Federal Reserve officials were concerned that a decision to keep securities holdings unchanged would inadvertently signal an intention to resume large scale asset purchases.

Also, a few policy makers said the economic effects of the decision “would be quite small,” but at the same time, some officials saw “increased downside risks to the outlook for both growth and inflation” and voiced concern that further shocks would cause “significant slowing in growth”.

The debate shows the challenge Fed Chairman Ben S. Bernanke may face in achieving consensus for any additional monetary stimulus to reverse a slowdown in growth and reduce joblessness more quickly.

In a speech last week, Bernanke said “Policy makers haven’t agreed on specific criteria or triggers for further action”.

In other important US economic releases, we had the Conference Board’s confidence index yesterday afternoon which showed that confidence among U.S. consumers rose more than forecast in August; a sign the biggest part of the economy may avoid a slowdown that would derail the recovery.

The Conference Board’s confidence index increased to 53.5 from a five-month low of 51 in July, figures from the New York- based private research group showed. More confidence may help ease concern that consumer spending, which accounts for about 70 percent of the economy, will falter.

As we approach the ECB meeting this Thursday, yesterday’s Eurozone annual inflation reading fell from 1.7 in July to 1.6 in August, coming in well under the ECB’s target of 2%. Inflation looks set to remain muted for the rest of 2010 and into 2011 as European governments implement austerity packages to shore up their sovereign balance sheets.

Yesterday we also saw German unemployment continuing to fall, for the 14 month in a row, slightly better than expected sparking a rally in the Eur/Usd which provided strong support going into the release of the Fed’s minutes. Investors had been keenly anticipating the release of these minutes but were somewhat disappointed as it lacked any new information triggering another move higher for Eur/Usd.

Sterling is trading up 50 points after the release of the Bank of England minutes showed one member, Andrew Sentance, voted to start the withdrawal of the exceptional monetary stimulus. This is the third straight meeting that Sentance has been the lone dissenting voice calling for a 25 basis point increase in the banks base rate.

He argued that the economic recovery is gaining momentum and the Bank needed to act to make sure inflation expectations are not allowed to deviate from current levels due to the current inflation rate stuck stubbornly above target.

Traders have taken this as a positive sign for the UK economy and the Pound now has just broken through 1.56 against the Dollar and 1.21 against the Euro.

The Euro regained ground against the US Dollar as Ireland’s 2014 and 2020 bond auctions largely passed without incident.

Spreads were already tightening ahead of the auction, and final bid-to-cover ratios of 5.4 and 2.4 respectively showed that demand remains firm.

Spain also sold 5.5 billion euros of 12- and 18- month bills at lower yields than in previous auctions in July. We wait to see if ECB intervention was the main reason for the strong demand.

The European data picture was less rosy, however, as the ZEW Economic Sentiment survey was much lower than expected at 14.0 (consensus. 20.0), though the current situation index was firm at 44.3 (cons. 24.0).

In contrast to the UK inflation figures falling yesterday eurozone inflation yesterday hit a 20 month high eu data has shown.
Annual inflation in the 16-nation bloc rose to 1.7% in July, up from 1.4% in June and the highest rate since November 2008, Eurostat said.

The figure was boosted by more expensive fuel costs for transport, and higher alcohol and tobacco prices.

Across all 27 nations in the European Union, prices were up 2.1% in July, compared with a rise of 1.9% in June.

Some countries – Finland, Greece, Spain, Portugal and Romania – raised their rates of VAT in July, which also helped to push prices higher.

On a month-on-month basis, prices in the eurozone fell 0.3% in July, and in the wider EU fell 0.2%.

UK inflation eased to 3.1% in July from 3.2% in June, the third month in a row that prices have risen more slowly than expected.
However, the Consumer Price Index (CPI) is still well above the Bank of England’s 2% target rate.

The Retail Prices Index (RPI) slowed to 4.8% from 5% in June, the Office for National Statistics said.  Sales signs Summer sales helped to push down prices, analysts said

The governor of the Bank of England will now have to write to the chancellor of the exchequer explaining why inflation is still above target.

The July inflation figures are watched particularly closely as they are used to set rail fare increases for the following year.

The changes affect regulated rail fares, which include long-distance off-peak journeys. This comes after some fares fell at the start of 2010, because RPI last July was -1.4%.

The main factor behind the drop in the inflation rate in July was a fall in transport costs, and in particular the prices of second hand cars and fuel.

Other factors included falls in the price of clothing and footwear.  These offset rises in cost of food and non alcoholic drinks.

Core inflation – which ignores volatile energy and food prices and is closely watched by economists – fell to 2.6% to 3.1%.

Last week, the Bank said it expected inflation to remain higher than forecast in the coming months, largely due to the rise in VAT to 20% in January.

The Bank’s governor, Mervyn King, said inflation was likely to fall back below the Bank’s 2% target in 2012.

The Bank of England has announced it is to overhaul its macroeconomic model (the excitingly titled- The Bank of England Quarterly Model) after a glut of large revisions to GDP and inflation figures.
In addition to the GDP forecasts it’s inflation forecasts haves been above target for 42 of the 51 months, triggering seven letters from BOE Governor Mervyn King to the Chancellor over the same period.

A chat over a few pints of beer and a packet of crisps are no longer deemed an acceptable method of assessing the health of the UK economy and the Bank plans to spend £3.5 million (or 350,000 magic eight balls) on overhauling and improving their forecasting model.

The announcement has led some commentators to suggest the markets may start to lose credibility in the Bank’s ability to forecast inflation and this could feed into Sterling weakness.

But since the story broke Sterling has hardly budged and along with us at Wise Money, the market probably sees the announcement as good rather than bad news.

The Financial Times yesterday also reviewed the BoE forecasts and discovered that the most reliable method of predicting future UK inflation and growth was to look at what happened in the previous quarter and copy those figures forward to the next quarter. Simples.

Speculation over the announcement of another round of quantitative easing (QE2) at tonight’s Federal Reserve meeting is reverberating around the money markets at present.The consensus seems to be that that additional liquidity will be added to the system through reinvestment of maturing assets already on the Fed balance sheet, rather than return to fully blown quantitative easing.

The recent surge in commodity prices after Russia placed a halt on exports of grain is a worrying development for the Fed, it will need to consider that further down the road after it may find certain parts of the economy experiencing inflation at the same time as others are suffering from rampant deflation.

This is why this Fed meeting is seen as so important– we wait to here which way the inflation/ deflation needle is pushed (unless we end up waiting until next month!).

Sterling continued its climb against the Dollar yesterday as momentum from Fridays disappointing US jobs figures continued in early trading.

But the Dollar has regained some ground this morning after the announcement from the Royal Institute of Chartered Surveyors that UK house prices have declined for the first time in a year.

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.

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 Pound Sterling has hit a new 19 month high against the euro as the 16 nation currency comes under renewed pressure.
The Pound rose almost half a cent to 1.2327 euros, its highest level since the immediate aftermath of the financial crisis in November 2008.

Markets are concerned ahead of a deadline this week for European banks to repay loans taken out a year ago at low interest rates.

Against the dollar, however, the pound fell more than half a cent to $1.5029.

The European Central Bank will offer funds on Wednesday to banks looking to repay loans later this week.

The euro has been under pressure since concerns about high levels of government borrowing triggered a debt crisis earlier this year.

But it is not just a weak euro that is boosting the pound.

Sterling has also benefited from comments made by Bank of England Monetary Policy Committee (MPC) member Andrew Sentance on Monday, in which he said the UK would need to start raising interest rates soon.

Mr Sentance voted to raise rates at an MPC meeting earlier this month.

Analysts said that if inflation remains well above the Bank’s 2% target rate, the pressure to raise rates will increase. Inflation, as measured by the Consumer Prices Index, currently stands at 3.4%.

Higher interest rates make sterling a more attractive investment and tend, therefore, to increase its value.