WISE MONEY

Yesterday we heard the particulars of recent the UK’s MPC and the US’s FOMC meetings and we also had euro ratings action from Moody’s, with very little resulting movement.The Pound dropped slightly following poorer than expected UK employment data but only lost ground following hard fought gains from Monday and Tuesday.

The main points from May’s MPC meeting were as expected and indicated no change in voting from April’s outcome.

However, the meat on the bones was always going to be the interesting facet, and so it proved.

The minutes suggest that the majority of members on the committee remain in no hurry to raise interest rates and although it is apparent that a wide division in views still exists, it is obvious that more members remain concerned about the downside risks to growth than about the dangers of stubbornly high inflation.

Moreover with the most hawkish member, Andrew Sentance, now set to be replaced by Ben Broadhurst, who seems to have a more balanced view on the economy, the make-up of the MPC would seem to be moving even further towards unchanged policy.

As a result, interest rates in the UK appear set to remain at the current low levels until the Autumn at least, with the November meeting now touted as the favourite for a tightening of policy.

The FOMC minutes, like those of the MPC, produced nothing earth shattering as the Fed Chairman, Ben Bernanke, had already prepared the market for a less dovish stance in his first press conference although again, the detail, when you dug down, was more revealing.

Markets were surprised by the extent of the discussions concerning exit strategies with officials outlining several guiding principals for the process of normalising monetary policy.

It was also clear that the majority of voting members favour raising interest rates prior to any asset sales as a means of tightening liquidity conditions.

Moody’s were also active, downgrading by 1-notch the credit ratings of the 6 largest Danish banks on fears of declining financial resilience.

None of this dented the Euro’s continued strength however with Asian markets preferring to focus on a report in The Times of China’s continued appetite for Eurozone sovereign debt as a means to diversify its foreign currency reserves away from the Dollar.

As expected, the Bank of England’s loans interest rates setting committee voted 6-3 in the last meeting where they left rates unchanged at 0.5%. They also vote 8-1 to keep the Quantitative Easing process at £200bn.

The minutes also gave us a view into how the MPC is thinking with members Weale and Dale seeing a case for a rate hike as “finely balanced” given the weak real economy and uncertain outlook.

Their outlook for inflation has not changed over the month with near-term looking worse than February, but likely to fall in medium term assuming the banks rate rises in line with market yields.

Going back to yesterday, the UK inflation data was woeful and although the pre-release rumours had pushed up the expectation, the +4.5% headline and +3.7% core levels were both higher than expected.

The headline was the highest rate since October 2008 but more significantly, the core number is now higher than it has been at any time since records began back in January 1997.

Interest rate futures and gilts both moved sharply in sympathy with the ‘higher rates sooner’ scenario and Sterling jumped across the board.

The strength however was very short-lived and the Pound ended up weaker on the day.

The probability of further ECB interest rate rises in the near term increased yesterday as the eurozone recorded another slight increase in the core cost of living index.
Given the hawkish tones (although they were slightly less so at the last meeting) of the ECB, one would expect the euro to respond positively to the prospect of higher rates, but sentiment remains weak in light of a continuing story regarding the head of the IMF, Dominique Strauss-Kahn, and its potential impact on the ongoing sovereign debt issues.

Mr Strauss-Kahn was refused bail and will remain in custody until his next hearing on the 20th May.

In his absence EU financial ministers did manage to approve the £65 Billion bail out of Portugal, the IMF providing around one third of the funds (the other two-thirds are from the 2 bail-out vehicles set up by the EU).

Over in the US President Obama again called for Congress to approve increasing the debt ceiling to avoid what he described as a potential “devastating economic and financial crisis”.

Republicans are aiming for guarantees on deficit reduction before they agree to a hike in the debt ceiling and the inertia is beginning to worry the markets, given the estimated day that the government runs out of money is the 2nd of August.

The Federal Reserve minutes from their last meeting are due today at 6pm, as ever the markets will be looking for comments on the economic recovery (especially on housing and the labour market) and anything regarding the end of QE2 and the Fed’s strategy once the easing has ended.

As Wise Money mentioned yesterday, the big news for Sterling this week looked set to be the Bank of England Quarterly Inflation report- and so it turned out to be. The Bank had to adjust growth projections downwards and suggested inflation will stay above target until at least 2013.

The key point for Sterling, at least for yesterday, was that the Governor hinted that interest rates will begin to rise towards the end of the year.

The latter seemed to dominate the former and the Pound rose strongly.

Whether or not this is a temporary blip as the market digests the lower growth projections and sells Sterling accordingly or we manage to hold on to these levels is fairly uncertain at this stage but there seems to be more downside risk.

That is because interest rate increases are not only dependent on the path of inflation and GDP, but also on bank funding costs relative to interest rates.

Put simply, what the Governor suggested yesterday is that funding costs need to fall before interest rates can rise, and given the current contagion fears throughout the Eurozone and the unwinding of the Banks SLF facility this year, the chances of that happening in the near to medium term look bleak..

Euro debt worries continue to spook the markets.

Inspectors from the IMF and EU visited Greece yesterday to assess current and future austerity plans, triggering protests in the Greek capital.

The EU looks set to extend maturity dates for Greek debt so unfortunately this story looks set to run and run – which is maybe the reason why it is not effecting the Euro as much as everyone thinks it should.

The Pound has shrugged off disappointing retail sales figures and a surprise drop in inflation earlier in the week and is trading up against the Dollar and Euro this morning. This is partly to do with the rise in British consumer confidence and positive employment data, but also is reflecting the fact that the market believes Tuesday’s CPI figure was merely a blip in the upward march of inflation.

The Bank of England has been working hard to keep our inflation expectations anchored recently, notice the increase in column inches of the MPC’s most hawkish member over the last few months.

But most of the subsequent reports by have been along the same lines: The fall in inflation is temporary and we expect prices to keep rising.

Does the market’s refusal to accept Tuesdays’ figure as a reversal in the inflationary trend mean the Bank of England is losing the battle of inflation expectations?

It means they are at least being questioned.

It also means the Bank needs to redouble its efforts in keeping wage and price growth expectations low and stable (unless you believe the conspiracy theory that the Bank is only aiming of nominal GDP growth).

Sterling remains vulnerable to an upturn in risk appetite especially given the diminishing likelihood of a UK rate rise at the May MPC meeting following yesterday’s inflation figures. The headline YoY number was reported as +4.00% in March against expectations of a +4.4% outcome.

This trend will encourage the view persistently expressed by Mervyn King and most of his BoE colleagues on the committee, that the recent spike in inflation was just that.

He has argued for several meetings that the MPC putting rates up as a counter to a sharp rise in imported inflation, when the spike is expected to correct itself quite quickly, is a pointless exercise.

This opinion looks more likely to be borne out following yesterday’s data, but could easily prove to be a 2-edged sword for Sterling.

The reduced prospect of interest rate rises in the UK combined with higher yields elsewhere leaves the Pound extremely susceptible to further declines against the Euro and commodity focused currencies.

The much reduced UK trade deficit was a bright spot, but the implication derived from the numbers is that the pick up in exports was as a result of the weaker Pound; a scenario that has been touted by both the BoE and the Chancellor, which again suggests little enthusiasm for any recovery in Sterling for the time being.

Yesterday, it was the turn of a Fed hawk, the Dallas President Richard Fisher, to air his views on current policy.

In an article published by a German newspaper this morning, he was quoted as saying that the Fed risks having maintained a monetary policy that is too expansive adding that, ‘It can now hardly be disputed that US businesses have enough financial fuel in the tank to grow and create jobs’.

He said that the Central Bank did what was needed when financial panic broke out back in 2008, but that the situation was much different.

Debate at upcoming FOMC meetings will become more intense with both doves and hawks seeking to sway Bernanke’s thinking their way.

The surprisingly better than expected US unemployment figures on Friday will likely switch the debate further towards a hawkish stance within the Fed. This week there is little to match the significance of jobs numbers in terms of market moving data this week. However, all eyes will be on the raft of Fed speakers over coming days coupled with the minutes of the FOMC meeting.

The Fed speakers under the spot light are Lockhart, Evans, Bernanke, Kocherlakota, Plosser and Lacker. Within this list only Lockhart and Lacker are non-voters.

Given the focus on latest Fed comments Currency markets will be searching for anything that points towards a broader Fed stance towards a quicker hike to interest rates and/or reduction in the Fed’s balance sheet.

Regardless the Greenback may struggle to make much progress ahead of an expected European Central Bank (ECB) rate hike of 25 basis point on Thursday.

However as ever much will depend on the press statement. If the ECB simply reiterates market prospects of around 75bps of policy rate hikes this year the single European Currency will struggle to remain strong.

In addition it maybe likely that once the ECB meeting is out of the way the EUR may finally be vulnerable to pressure related to continuing peripheral tensions.

The results of the Irish bank stress tests last week, and political vacuum in Portugal ahead of elections set for June 5 were well absorbed by the EUR but it is debatable whether the division between increasing peripheral bond spreads and the EUR can carry on- evidence that finally the currency maybe regaining its mantle of funding currency.

It remains too early for the Bank of England to increase rates regardless of growing inflation readings and MPC members are expected to wait for the next months Inflation Report before a crucial shift in favour a rate rise.

At this point, members will have to tackle with the issue that economic data remains somewhat restrained as suggested in the weaker than expected March manufacturing PMI data.

Today is all about inflation and just how much of the increasing price pressures are being absorbed by industry and retailers and how much is finding its way onto the consumer. The headline figure has come in at +0.7% m/m, +4.4% y/y, stronger than median forecasts +0.6%, +4.2% respectively which in the highest y/y rate since October 2008.

According to the Office for National Statistic the biggest upward impact on CPI came from housing, domestic heating bills and clothing.

In addition the PSNB in February at £10.280 billion, worse than median forecast of  £8.0 billion.

PSNCR came in at  £6.981 billion compared to median forecast  £4.2 billion.

Public finance data makes poor reading just ahead of the Chancellors’ Budget tomorrow.

Expect Sterling to pick up further today based on the high number but as to whether this is a correct move remains to be seen.

With growth expectations anticipated to be revised lower by the OBR, an immediate raising of rates looks likely to be counter-productive.

With Trichet again cementing the prospect of a rise in Euro rates next month, the single currency appears the likely recipient of short-term differential trades.

We are due no further relevant data today so Central Bank comment should prove to be the catalyst for additional forex volatility.

Japan’s Nikkei index opened over 2% higher after a holiday closure yesterday despite the nuclear situation remaining on high alert.

According to atomic officials, Fukushima Daiichi’s reactor 2 remains a danger as white smoke continues to drift into the sky from the plant.

The surrounding areas are now experiencing levels of higher-than-normal radiation up to 120 miles away.

Following last week’s intervention the JPY has been restored to relative normality against the USD and currently sits at 81.09.

George Osborne is set to announce his first budget on Wednesday, on the same day we also see the latest Bank of England minutes and tomorrow last months CPI inflation figure is released. Starting with the Budget, there are not set to be any new tax hikes or spending cuts in the announcement, with the Chancellor set to focus on trying to stimulate growth.

This should be broadly Sterling positive especially if he manages to persuade high profile businesses to move back to the UK.

The Bank of England minutes should also be very interesting, a 5-4 split should indicate an interest rate rise sooner rather than later.

Another 6-3 result would confirm the current market thinking that a rate rise before Q4 is looking increasing unlikely.

Finally, the CPI figure will closely watched but it not as important as previous month.

Wise Money expects the inflation rate to increases once more, but the credibility of the BoE will only come under further scrutiny if inflation fails to fall back towards target as the bank is currently predicting, and the current supply side shocks in oils and commodity prices turn out to be permanent rather than temporary in nature.

Last weeks combined intervention by central banks in their respective Yen pairs was broadly successful in curbing the rampant Yen strength in the aftermath of the last week’s earthquake.

More intervention is rumoured to be on the cards this week so if you are selling Yen you will need to keep a close eye on the rates.

We do have Japanese CPI figures due for release later in the week, but expect that to play a small roll in the Yens value moving forward in light of the events still evolving in Japan.

The Reserve Bank of New Zealand (RBNZ) decision to reduce interest rates by a 50bps as opposed to the widely anticipated 25bps has not led to the beginning of a new wave of Kiwi selling. The NZD was helped by comments from the RBNZ Governor Bollard that short term inflation may rise as a result of the earthquake however this was tempered by another RBNZ official who stated that the central bank may hold rates at 2.5% at least until January next year.

The post meeting statement indicated that the RBNZ will not start on a series of rate cuts, a point that will offer some assistance to the Kiwi.

In addition, the currency appears increasingly oversold particularly in relation to the Aussie as shown by relative levels.

Continuing on the interest rate theme and the Bank of England is the next central bank in line however is doubtful they will raise rates despite the hawkish shift within the Monetary Policy Committee.

A rate hike is definitely not far away however the Bank will likely wait until at least May in order to examine the UK’s Q1 GDP.

As ever the details about today’s decision will be in two weeks time as we see the split between the MPC.

Thus far Sterling looks vulnerable and whilst a rate move today is not expected the currency may lose ground over coming days against the background of a firmer USD. Cable currently sitting close to the low of 1.6121 at 1.6148.

In other news, Portugal moved closer to a EU bailout yesterday as it faced surging borrowing costs on €1 billion bond sale. The debt-stricken state sold the 5.45% bond which matures in 2013 at a much higher and expensive price of 5.993%.

Despite the high level, the Portuguese remain defiant regarding the topic of possible EU intervention. “These are rates that are not sustainable in the longer term, but they are still bearable at the moment” said Carols Pina the Portuguese Treasury secretary.