Foreign Currency Report 07 December 06

GBP

Sterling fell more than half a percent against the dollar and weakened against the Euro yesterday after the UK pre-budget report was overshadowed by weak UK data and strong U.S. data.

Sterling initially rose slightly after Chancellor of the Exchequer Gordon Brown said in his pre-budget report that the economy would grow 2.75 percent in 2006; up from an earlier forecast of 2.0 to 2.5 percent. The forecast for growth in 2007 was kept at 2.75-3.25 percent but he did raise the estimate for the economy's long-term potential growth to 2.75 percent.

However, the pre-budget report was not expected to heavily influence sterling. "The Treasury do have a good record for forecasting growth and it's a good sign (for the economy)," said Gavin Redknap, economist at Standard Chartered.

Sterling had already started on the back foot early yesterday after UK industrial production data came in below expectations. Manufacturing output fell 0.4 percent on the month, against expectations for a 0.2 percent rise, the biggest monthly drop since Oct 2005. Industrial production also dropped 0.8 percent on the month against a forecast 0.1 percent gain, the biggest monthly drop since Aug 2005.

Investors are focusing on expectations the Bank of England will put a hold on rates at the current level of 5 percent today. It will however be paramount to not only keep an eye on the rate decision today but also the comments that accompany it. A hint that future rate hikes will be limited in the UK may result in Sterling losing some of the gains that it has made against a basket of currencies in recent months.
The BoE rate decision is due at 1200 GMT today.

US Dollar

The dollar had its biggest gain in three weeks against the yen and progressed against the Euro after a report showed U.S. companies in November added the most workers since June. The government's monthly labor data to be released on Friday looks set to dampen speculation the economy is weak enough to push the Federal Reserve to cut interest rates next quarter. The gains do look to be limited versus the Euro however in light of the expected raise by the European Central Bank in its benchmark rate tomorrow.

The labor data ``seem to suggest there could be some upside to the employment numbers,'' said Dustin Reid, a senior currency strategist at ABN Amro Bank NV in Chicago. ``That could be giving the dollar a lift.''

Companies in the U.S. added 158,000 jobs last month, according to an ADP Employer Services report based on a sampling of 225,000 businesses.

This data will be important to follow as if it does come in as strong as is expected then we may see a lull in the current weakening of the dollar.

Euro

Today we are expecting to see the ECB (European Central Bank) increase interest rates to 3.5%. This rate hike has already started to be priced into the market so it will be key to listen to the comments made by ECB President Jean-Claude Trichet that follow the rate decision. Trichet may continue to re-affirm his stance of 'vigilance' in the face of inflation during his press conference tomorrow This will pave the way for rates to go higher in 2007 to restrain inflation.

``If Trichet uses the word `vigilance' it will be hawkish,'' said Matthew Kassel, director of proprietary trading at ING Financial Markets LLC in New York. ``It has been a code word to signal further rate hikes by the ECB.''

The Euro is close to a two-year high against the dollar and at a record against the yen, yet Trichet is ignoring calls from French politicians, including Prime Minister Dominique de Villepin, to stem its climb. This suggests Trichet is optimistic the Euro region's economy can cope with a stronger currency, giving him leeway to keep raising interest rates next year. The likely hike to 3.5 percent will be the sixth move in a year for the ECB.