Foreign Currency Report 19 September 06

GBP

Sterling erased early gains to stand down yesterday with investors focusing on the release of the Bank of England's minutes from its September meeting due this week for clues on the UK interest rate outlook. The Euro was rising across the board on hawkish comments from European Central Bank officials which reinforced expectations of higher interest rates, pressuring sterling in the process.

The minutes of the Bank of England's September meeting, due tomorrow, are expected to show a decision to leave interest rates steady at 4.75 percent was unanimous.

Paul Robson, currency strategist at Royal Bank of Scotland, said sterling selling was due to general flows in the market.

"It's hard to tie down to any particular news. But from now on it would be interest rates that would move sterling. At the moment people are certain the BoE goes in November, so the risk is that the minutes might be softer'. If the minutes are soft then any current strength that Sterling has could be lost in a very short space of time.

A Bank of England survey showed Britons' expectations of future inflation steadied in August, but were still way above the central bank's 2.0 percent inflation target. British finance minister Gordon Brown suggested over the weekend that economic growth this year would turn out stronger than forecast in his budget. In the March budget forecast Brown predicted growth of 2.0-2.5 percent.

USD

America's trade deficit increased in the spring to the second highest level in history, reflecting a big jump in payments for foreign oil and a deterioration in the country's investment position. The deficit in the U.S. current account rose to $218.4 billion in the April-June quarter, an increase of 2.4 percent over the first three months of the year, the Commerce Department reported yesterday.

The current account is the broadest measure of foreign trade. It covers not only trade in goods and services but also investment flows between countries. The deficit represents the amount the United States must borrow from foreigners to cover the shortfall between exports and imports.

Democrats called the widening of the deficit further evidence that President Bush's free-trade policies have left American workers exposed to unfair trade competition and a steep loss of manufacturing jobs. With just seven weeks left until the congressional elections, Democrats are hoping voter unhappiness with the rising trade deficit will help them win control of the House and Senate. This political uncertainty leaves the dollar open to risk and looking for direction in the coming months.

Euro Zone

The Euro edged higher on Monday after hawkish comments from European Central Bank officials. Oil prices rose from last week's 6-month low having experienced their steepest slump in more than a decade due to robust winter fuel stocks and easing geopolitical and weather risks to supplies.

Over the weekend during the G7/IMF meeting in Singapore, ECB officials reinforced expectations for higher interest rates, stressing economic strength and inflation risks. As a result, financial markets are now pricing in around an 85 percent chance of rates rising to 3.75 percent by mid-2007.

"ECB officials appear to be preparing the market for a probability of interest rates rising beyond 3.50 percent," said Wee-Khoon Chong, strategist at Bank of America. "People in the market are gradually hardening a view that rates might go to 3.75 percent by June."

If this is to happen then we will more than likely see the Euro strengthen and therefore become more expensive to buy, so why not take advantage of Sterling's current strength in the market.