Sterling falls as ECB Rate Hike Threatened

GBP

The pound has suffered heavily yesterday as expectations for an early UK rate rise were scaled back after a below-forecast purchasing managers’ survey on the key UK services sector.

Markets are pricing in a 25 basis point hike from the record low 0.5% in June or July, with potential for a further two hikes potentially by the end of the year. This new market prediction could mean that the expected change in policy for May now looks unlikely.

Analysts are continuing to remain worried by the fragile economy and concerns about the vulnerability of the UK as the government embarks on harsh austerity measures that could see disposable incomes squeezed by higher taxes and commodity prices, which are likely not to be offset by higher wages.

Bank of England Deputy Governor Charles Bean hurt sterling yesterday after comments stating that inflation in 2011 may be above the BoE’s current forecasts but that did not mean rates should rise faster than markets expect. He also said that a rate rise before the summer months looked unlikely.

The worries about the fragile economy were compounded yesterday on the release of a disappointing services PMI for February, with the data raising many questions as to how strong the rebound in the economy really will be in Q1. Unsurprisingly, the pound eased back from the 13 months high versus the US Dollar and to a 2 month low against the ever-strong euro as we stare a double dip recession in the face.

EUR

In contrast to the pound the European Central Bank President Jean-Claude Trichet was in an extremely hawkish mood in his post meeting press conference, after keeping the base rate at a fixed 1%.

A 25 basis point increase now looks likely next month in response to rising inflationary pressures. The ECB statement said that “strong vigilance” is warranted to contain upside risk to price stability.

Strong vigilance was the phrase typically used by the ECB one month before it raised rates during the last rate move between 2005-07.

Trichet indicated that rate hike is possible next month, but ruled out that this is may start a series of rate hikes. A ‘suck it and see’ approach if you like.

The ECB has certainly ramped up the inflation rhetoric over the past month, with several warnings from council members about the need to contain rising price pressures.

Markets are now pricing in the rate increase next month and the euro is benefitting, by testing a near 2 month high against the pound and getting close to breaking the $1.40 level versus the dollar.

USD

The Greenback has been battered this week by the unrest in the Middle East and the impact on commodity prices. It has struggled to hold into its safe haven status also.

Some respite may be sought today however, as its near-term direction hinges on the US non-farm payrolls data due later on Friday. Analysts in a Reuters poll expect the report to show a rise of 185’000, following a tepid 36’000 increase previously.

Markets will be looking for a better than expected figure, but a disappointing number could fan worries about the outlook for the US labour market, especially given uncertainty about how the recent surge in oil prices may affect the US economy and companies.

Asian stocks are heading for their biggest weekly gain in nearly 3 months on bargain-hunting after their recent drop while the euro perked up after the central bank signalled a rate hike as early as next month.

Overnight gains brought stock to near levels since the Libyan crisis erupted; indicating markets have been largely resilient to oil’s 15% surge in the past 2 weeks.