FX Market Summary 08-07-2013: Sterling surge on BOE policy shift

Asian trading on Wednesday was marked by a sharp 4% decline in the Nikkei index which put risk appetite generally on the defensive. The yen gained significant support from the decline in regional equity markets and USD/JPY dipped to six-week lows below the 97.0 level as the US currency also struggled to gain wider support.

Chicago Fed President Evans was generally more upbeat surrounding the US economic outlook with greater confidence in the labour market. He indicated that a September Fed tapering was realistic and this is important given his normal dovish stance. A noticeable trend, however, was that the dollar found it difficult to gain support from Fed talk.

There had been a high degree of nervous anticipation surrounding the Bank of England’s latest inflation report and the price action certainly demonstrated why it was such a big event. As far as the inflation report is concerned, there was an upgrading of the GDP growth forecast to 1.4% for this year from 1.2% and next year’s forecast was revised to 2.5% from 1.7%.

The bank, under new Governor Carney, introduced a fresh set of forward guidance for monetary policy. Under the new regime, interest-rate levels will be influenced by the level of unemployment as well as the inflation rate. In effect, the Bank of England will pledge not to raise interest rates until unemployment falls below 7.0%, although there are some knockout clauses with action possible if inflation is projected to be above 2.5% on an 18-24-month horizon.

Sterling dipped briefly following the announcement as GBP/USD hit a low near 1.52 and EUR/GBP moved to above 0.87. The move reversed quickly and the UK currency then advanced very strongly as players were caught out by the strong reversal and forced to cover short positions. This quickly cascaded into strong buying as GBP/USD pushed to a high above 1.55 while EUR/GBP dipped to below 0.86 in very volatile trading conditions.

There was a strong German industrial production report which helped support the Euro as underlying confidence in the Euro-zone economy improved slightly. EUR/USD trading was influenced strongly by developments on the main crosses and market conditions were very choppy. Selling in EUR/JPY as equity markets fell was initially an important drag as EUR/USD dipped to the 1.3265 area during the European morning. The Euro then found fresh support as dollar selling against Sterling had a knock-on effect and EUR/USD pushed back above the 1.33 level.

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