FX Market Summary 05-21-2013: Inflation Fall Undermines Sterling

Principal attention during the European session on Tuesday was focused on Sterling as it dipped sharply to lows below 1.5150 against the dollar and also retreated to test key support at 0.85 against the Euro.

The UK currency was undermined by a weaker than expected inflation reading with consumer prices falling for the first time in nine months. This decline pushed the annual headline inflation rate down to 2.4% from 2.8% previously and compared with consensus expectations of 2.6%.

The weaker than expected outcome increased speculation that the Bank of England would have greater scope to sanction additional quantitative easing over the next few months. A lower inflation rate would certainly strengthen incoming Bank Governor Carney’s position if he looks to pursue a more aggressive monetary policy to help stimulate demand within the economy.

The Euro was confined to relatively narrow ranges during the session as it hit resistance close to 1.2900 while support emerged on dips to below the 1.2850 level. Consolidation was the general theme as markets waited for fresh incentives. There was an important mood of caution ahead of Fed Chairman Bernanke’s congressional testimony due on Wednesday amid uncertainty over hints of any tapering of bond purchases. Regional Fed President Bullard stated that an adjustable quantitative easing remained the best policy fit, especially with interest rates close to zero.

On the Euro-zone front, there was uncertainty ahead of flash PMI manufacturing releases due on Thursday as confidence in the economic outlook remained extremely fragile. Players were reluctant to extend bullish dollar bets, even though the underlying currency tone remained positive. Following another successful test of support in the 1.2850 region, there was a fresh advance to test resistance above 1.29 as European markets closed.

Not for the first time, there was evidence of confusion among Japanese policy-makers with Economy Minister Amari downplaying his comments from the previous day which seemed to suggest that the yen had fallen far enough. There was a partial retraction of these comments on Tuesday which dampened immediate demand for the yen as corrective gains quickly ran into fresh selling pressure.

The dollar found solid support on dips towards the 102 level against the yen and rallied strongly to a peak above 102.80 at the US open before faltering again as resistance near 103 held firm. The yen failed to gain any major support ahead of Wednesday’s Bank of Japan monetary policy decision with markets are not expecting any further stimulus at this time.

Elsewhere, the Australian dollar briefly moved above the 0.98 level before fresh sellers were attracted in and it retreated to the 0.9750 area in early US trading before finding solid support.

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