Higher than expected inflation drove Sterling higher at the beginning of last week, and it briefly hit 1.20 to the Euro. The Euro then strengthened toward the end of the week amid speculation that European leaders will resolve their debt crises.
Indeed the Chicago Mercantile Exchange reported that investors purchased $8 billion worth of Euros in the seven days leading up to January 18th. This is a record for a single week and explains why the Euro jumped up despite a lack of data. The shift in sentiment is due to the rumours of a more radical response to the peripheral debt concerns.
Also causing the Euro to strengthen is the resilient German economy. Markit’s Eurozone Flash Services Purchasing Managers’ Index rose to 55.2 from 54.2 in December. This was much better than the expected 54.3 and was largely due to strong indicators in Germany. Any number above 50 is considered to be positive.
The Pound slumped against the Euro on Friday after UK retail sales dropped by the most on record for December. Sales slumped 0.8% from the previous month, when they advanced 0.4%, as wintry weather conditions prevented shoppers from hitting the high street. Retailers are likely to face further pressure for the recent increase in VAT and high inflation. Consumer spending is likely to slow over the coming months, which could affect the economic recovery.
The week ahead is looking to be important for Sterling, as three key pieces of information are released. On Tuesday at 0930 both public sector net borrowing and fourth quarter preliminary GDP will be released. Currency markets will react positively to a reduction in. Any indication otherwise will lead to calls for the coalition government to increase public sector cuts, which could also impact the economic recovery.
The fourth quarter GDP figure will show how quickly the economy grew at the end of 2011. Anything above 0.4% will be received positively and suggest that weak sterling and a flexible labour market are causing production to pick up. The last two quarters of GDP were comfortably above expectations and suggested that the UK will be able to recover from recession.
We will also see the Bank of England Monetary Policy Committee minutes, which are released on Wednesday. Rates are unchanged but there is considerable interest in the conflicting views of committee members. Previous meetings have seen Andrew Sentence voting to increase interest rates with Adam Posen voting to increase quantitative easing. With inflation rapidly heading toward 4% we expect some tightening of monetary policy with interest rates increasing by the end of the year.
Over in America the Federal Open Market Committee (FOMC) are meeting on Wednesday for the first time this year and fourth quarter GDP is released on Friday. In a similar vein to the UK this will provide the US Dollar with direction, as these are key data releases.
Additionally central banks in Japan, Hungary, Norway and New Zealand meet this week. Japan as ever will be watched closely as it is the 3rd most traded currency in the world. Interest rates are expected to rise in Hungary.
