Euro Strong as Sterling Slips Back

The pound has fallen back against the US Dollar and the euro after the green back rallied on strong US housing numbers and some real money accounts reallocated funds away from the pound to the single currency.

Sterling was feeling the pressure also from mixed UK industrial trends survey that highlighted the dilemma facing Bank of England policymakers.

The pound was down 0.8% against the dollar at $1.5864, off a high of $1.6010 and an eight week high of $1.6060 that was hit earlier this week. Stop losses were triggered after the move below $1.5910 and then sub $1.59.

The UK currency has been well supported since higher-than-forecast UK inflation data on Tuesday caused investors to bring forward expectations for when the BoE will hike rates, with a 25 basis point rise fully priced in by around mid-year.

Market watchers are however wary that a weak economy and harsh austerity measures to come mean a rate hike is not a done deal.

Data on Wednesday showed UK unemployment rose at its fastest pace in 8 months in November against a backdrop of weak pay growth.

AIB Group Treasury Geraldine Concagh said: “Sterling is highly volatile in relation to interest rate speculation and we could see a good deal of volatility in the next few months as it reacts to various data.”

Data of note next week will be the release of the minutes from the January Bank f England policy meeting, which will likely give an indication of how concerned policymakers are about high inflation, as well as fourth quart (2010) gross domestic product data.

The euro has extended gains against the dollar to briefly hit a fresh two month high overnight after Germany’s IFO survey showed improving business sentiment in Europe’s largest economy.

The euro rose to a high of $1.3566 after the data, from around $1.3557, before pulling back slightly.

It is still up by over 0.5% and when you consider the very difficult start to the year that the single currency has seen thus far, any positive market movement of significance is noticeable.

The dollar gained broadly on Thursday as an array of US data suggested the US economy is firmly on a path of recovery, but growing confidence in Europe’s ability to defuse its debt crisis should limit the greenback’s gains against the euro.

US Fed monetary policy largely relies on labour market conditions and the pace of economic recovery, so signs of improvement increase expectations of higher interest rates, which in turn makes the boiler more appealing to investors.

“Most of the reports today were fairly good. For anyone skeptical about the U.S. recovery, these should ease concern," said Kathy Lien, director of research at GFT Forex in New York.

"It suggests the U.S. economy is moving in the right direction and investors are buying the dollar, as there are concerns outside U.S. borders," she said. "The combination of strong U.S. and Chinese data today is something to be optimistic about."

The dollar's biggest gains were against its safe-haven rival currencies.

Higher yielding currencies were the biggest losers yesterday, as sentiment swung in favour of the US Dollar.

The Australian Dollar, which fell 1.3% against the US Dollar, is particularly sensitive to the performance of the Chinese economy as Australia is a major supplier of natural resources to China. Continued speculation of higher Chinese rates tends to weaken the Aussie as such action would cool growth, decreasing demand for resources.

A Reuters report this week suggested that Asia’s rapid economic growth will moderate slightly in 2011 even as policymakers combat rising prices with higher interest rates and try and keep local currencies from appreciating too sharply.

Most of the 13 Asia-Pacific economies in a Reuters survey are expected to see growth cool in 2011 from 2010 as economic recoveries in the United States and Europe remain uneven and China steps up its effort to fight inflation and asset bubbles.