Will the Bank of England be the First to Cut Rates?

  • Will the Bank of England be the First to Cut Rates?

  • Dollar Slips As GDP Falls Short of Expectations

  • Another Batch of Stronger Eurozone Data Will Keep ECB on

US Dollar

The dollar took a nosedive after this morning’s GDP report as
the numbers tell us that the US economy is growing, but at a slower pace
than last quarter. GDP accelerated by 3.4% in the second quarter, down from
3.8% in the first quarter. The disappointment was only a mere 0.1%, but
there were a good number of traders in the market expecting a much stronger
number following the recent chain of improving US economic data. As a
result, we saw a sharp slide in the dollar against the euro. However at
least half of those losses were recouped as the market realized that even
though inventory growth dragged overall growth lower, other parts of the GDP
report did give a cause for optimism. More specifically, final sales surged
5.8% in the second quarter, up from 3.5%. The recent narrowing of the trade
deficit also added 1.57% to GDP, which was the largest contribution since
1996. Overall, exports increased by 12.6% while imports fell. It still
remains to be seen whether the shrinking of the trade deficit will continue
given the elevated level of oil prices. Another sliver of hope for growth
was the 9.9 point surge in the Chicago PMI report. After this week’s
stronger durables goods orders report, there are more and more signs of a
recovery in the manufacturing sector. With the housing market and
manufacturing sector both holding on strong, the case builds for another
optimistic statement from their Fed in a week and a half. Non-farm payrolls
is due for release next Friday, which should be the focus of the market next
week. Based upon the recent string of data, we expect another strong triple
digit increase. This means that for the time being, even though inflation
reports are diverging from the trend of oil prices, there is no stopping the


Aside from German retail sales, today brought on another batch of stronger
Eurozone data. For most of this past week, we have been seeing more evidence
of a recovery and a turnaround in the Eurozone economy. Following yesterday’s
drop in German unemployment, French unemployment also fell by 28,000, which
is the first time in 5 months that the country has seen an improvement in the
labor market. Unemployment in Spain also hit a record low in the second
quarter. Thanks to the improvements, Eurozone economic confidence rose from
96.3 to 96.7. Yet confidence was not completely widespread as French consumer
pessimism remained at a record low. German retail sales fell 0.3% in June,
but an upward revision to the May data offset most the increase. The flash
estimate of Eurozone headline inflation increased to 2.2% from 2.1%. Taken
together, improving data and rising inflationary pressures in the Eurozone
will continue to keep the ECB’s hands tied from lowering rates even though
politicians in Italy are complaining about the disastrous effect the Euro has
had on growth. As a result, we do not expect any surprises at next week’s ECB
meeting. Trichet and his team should remain committed to keeping monetary
policy unchanged.

British Pound

The British pound grinded higher for the third consecutive day thanks to a
rebound in UK consumer confidence. Given that the most recent release
includes sentiment following the London attacks, the improvement was probably
attributed to UK consumer expectations for a rate cut by the Bank of England.
This is the first meeting in a long time where we have the market and
economists somewhat divided on the outcome. Most economists do expect a
quarter point rate hike on August 4th, but based upon the latest
price action, it does not seem that the market is as convinced of a move.
There is good reason for traders to stand on both sides of the fence. While
the BoE could deliver a rate cut to spur optimism following the London
attacks, especially since last month’s vote was on a narrow 5-4 margin, the
strength of the latest retail sales report and recent rebound in confidence as
well as still buoyant inflationary pressures could tempt them to keep rates
unchanged for yet another month. Regardless as we currently stand, the Bank
of England is on its way to becoming one of the first major central banks to
cut rates this year. It seemed as if it was only yesterday, that they were
one of the first central banks to raise rates back in November 2003.

Japanese Yen

The Japanese yen sold off modestly today against the
dollar despite some rather promising news. Industrial production rose
unexpectedly by 1.5% last month while the jobless rate fell to 4.2%, the
lowest level in 7 years.
China also came out with more contradictory
talk. Today the People’s Bank of China Governor Zhou was quoted as saying
“from now on, the yuan rates’ fluctuation will not be because of government
adjustments.” The market has taken this in stride because for the most part,
he is only stating facts – the currency now fluctuates 0.3% based upon the
previous day’s rate and not based upon the 8.11 rate that was set on July 21
so the market does have a hand in the currency’s fluctuations. Yet
nonetheless, we also know that China has an interest in encouraging a gradual
appreciation in the RMB, which will be positive for the Japanese Yen over the
longer term. Weakness today could then be attributed to another rally in oil
prices and a drop in worker’s household spending. The market had expected
spending to increase but it actually fell by 1.4%.

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Kathy Lien

Kathy Lien is the Chief
Currency Strategist at Forex Capital Markets. Kathy is responsible for
providing research and analysis for DailyFX, including technical and
fundamental research reports, market commentaries and trading strategies. A
seasoned FX analyst and trader, prior to joining FXCM, Kathy was an
Associate at JPMorgan Chase where she worked in Cross Markets and Foreign
Exchange Trading. Kathy has vast experience within the interbank market
using both technical and fundamental analysis to trade FX spot and options.
She also has experience trading a number of products outside of FX,
including interest rate derivatives, bonds, equities, and futures. She has a
Bachelors degree in Finance from New York University. Kathy has written for
Stocks and Commodities, CBS Market Watch, ActiveTrader, Futures and SFO
Magazine. She is frequently quoted on Bloomberg and Reuters and has taught
seminars across the country. She has also hosted trader chats on EliteTrader,
eSignal, and FXStreet, sharing her expertise in both technical and
fundamental analysis.