Euro Dominates both GBP & USD

The euro has come back fighting in the second half of this week, which has shocked market watchers after yesterday’s solid Spanish debt auction and comments by European Central Bank President Jean-Claude Trichet that the euro zone faces short-term inflationary pressures added fuel to a short-covering rally in the euro, against most notably the pound and US Dollar.

Indeed the euro is now on track to post its best weekly performance against the dollar in 20 months all of which can be attributed to the hawkish comments by the ECB yesterday that caught markets off guard.

Hints that the ECB could lift interest rates to contain inflation, even while the bloc was tackling a debt crisis signals its intent and confidence in its own strength.

Whether this proves to be the case or not remains to be seen, but the initial reaction on the market is clearly worth taking note of as the euro strength is palpable.

The euro’s rise marked an impressive turn around from a four-month low, around $1.2871 on Monday and set the scene for a retest of the December high of $1.35. It is up around 3.5% this week. Against Sterling is a similar story with markets moving around 2.5% which has snatched the chance of many euro buyers to lock in prices at €1.20 with the market now plummeting down to €1.17.

The pound has risen to one-month high versus the dollar after Thursday’s trading session helped by a short-covering rally in the euro and expectations from some market players that a rise in UK interest rates may come sooner that expected in 2011.

The Bank of England kept to expectations and didn’t adjust their stance on the current 0.5% base rate. Rising inflationary pressures and higher UK yields have however prompted money markets to price in a strong chance of a rate hike as early as May.

Sterling vs. US Dollar now looks set to test the $1.5990 level as it did in September last year, with the opposite to be said for the euro market.

Sterling lost some ground against the euro after trading at 1.2040, it has sunk heavily as the single currency gained much needed respite from solid demand at bond auctions in Spain and Portugal, largely from Japan and China as they snap up euro debt. This together with suggestion that the European Union may take further steps to tackle sovereign debt worries in the euro zone weighed on the pound as the single currency found support

British industrial output grew in November at its slowest annual pace since July, dragged down by continued weakness in the oil and gas sector and despite strength in manufacturing official data showed yesterday.

Industrial output rose 0.4% after October’s 0.1% decline. However, that was a smaller rebound than the 0.6% analysts expected. Manufacturing output grew slightly faster than forecast, matching October’s monthly rate of 0.6^ which was the strongest since March.

The US Dollar’s significant movement yesterday came in the form of weakness against the dominant euro after the hawkish comments from ECB President Trichet, as strong demand for Spanish paper eased debt woes.

Market’s rose to a one month high and broke above its 100 day moving average.

The US will look towards a busy data day with retail sales, industrial production and CPI figures for December set to be released this afternoon to try and turn around the seemingly one-way traffic that we saw yesterday.