Direct FX Weekly FX Update 18th April 2011

Last week's price action in the foreign exchange markets proved to be interesting to say the least. The intense focus on the European debt situation remains, with the prospect of a Greek debt restructure causing the most debate. Lower than expected inflation numbers in the UK and the US provided some insight. These numbers certainly reduces the pressure on Bank of England and the Federal Reserve to remove their accommodative policies for the time being. The Australian and New Zealand dollar's remain in demand, with the NZD being the star performer of the week. Expectations for the Japanese economy have been lowered as the cleanup of the devastation stretches out. The Fukushima power plant fallout worsened and this has seen its rating lifted to 7, the same level to that of the Chernobyl disaster. The commodity markets remain strong, with gold setting record highs and oil remaining at elevated levels on geo-political tensions.

The Australian dollar has remained in demand over the last week, albeit its progress somewhat slowing. It saw a new post float high of 1.0581 and starts this week close to that level. A higher than expected inflation number in China saw another 50pt rise in the bank reserve ratios over the weekend from the Chinese authorities. This is an effort to slow bank lending and therefore help reduce inflationary pressures. One might expect this to impact on the performance of the AUD, given its close correlation to the Asian growth profile, but there was no impact as the market opened today. The focus this week will be Tuesday's release of the Reserve Bank of Australia's monetary policy meeting minutes, and the quarterly Producer Price Index numbers on Thursday.

In the absence of any local data in New Zealand last week, the driver for the New Zealand dollar's stand out performance were comments made by Reserve Bank of New Zealand Governor Bollard. He commented on the persistently high level of agricultural commodities due to the growth in Asian demand, and the flow on effects of New Zealand export earnings creating inflationary pressure. A five percent increase in the exchange rate roughly equates to a 25pt hike in the cash rate. It would appear from comments like these, that Dr Bollard is happy to let exchange rate appreciation do some of his work for him. Lower than expected inflation numbers in the UK and the US mean that the NZD was pushed higher on interest rate differentials. This happens as the market pushed out the timing of hikes expected from the respective reserve banks. Today's NZ CPI inflation number of showed +.8% increase for the quarter against expectations of 1.0%. This saw the NZD sell off across the board by around .3% and is the only significant piece of economic data in New Zealand this week. Of note also is the offshore demand for the increased New Zealand Government bond tender program. The New Zealand Debt Management Office has had no problems issuing bonds in the Governments enlarged borrowing program.

The United States dollar remained under pressure for the most part last week. The continued high level of the oil price meaning that any progress from the USD was going to be hard fought. The economic data continues to show improvement for the most part, with manufacturing and consumer sentiment providing the highlights. This week's focus will be on building permits numbers on Tuesday, homes sales numbers Wednesday and more manufacturing numbers Thursday. I do think we should see some kind of USD strength return at some stage in the short term. This will probably come with some kind of resolution of the tensions in the middle East/North Africa regions, and the associated drop in the oil price. Next week's Fed meeting and statement on the cash rate will be focused on as the debate around the removal of stimulus increases. The lower than expected inflation number last Friday will give Chairman Bernanke some assurance that inflation remains in check for the time being.

In the UK, the big event of the week was the inflation number that came in at 4.0% for the year against a market expectation of 4.4%. The release of this number saw a softer GBP across the board as any chance in the lift of rates in May from the Bank of England vanished. With the prospect of no change in the cash rate until August or October, the Pound Sterling remains vulnerable to downside pressure. This week attention will be on the Bank of England Monetary Policy Committee meeting minutes due for release on Wednesday, followed by the monthly Retail Sales number on Thursday.

The European debt crisis continued last week. With debate heating up on the prospect of debt restructuring for Greece and the double level downgrade of Ireland by Moody's getting the most attention. The EURO has been remarkably resilient through this recent focused attention. Diversification away from the USD has continued, and along with the prospect of higher interest rates, has been providing the support to the EURO. The slightly higher than expected inflation numbers last Friday will keep the European Central Bank on the inflation offensive and this should continue to see the interest rate differentials providing key support on any debt inspired EURO weakness. China has also expressed its support for Spain, and Spanish bonds. With little in the way of major European economic data this week, again the focus will be on the peripheral member states and their debts issues.

Last week the Bank of Canada left the cash rate unchanged at 1%. The comments accompanying the decision have been taken as more downbeat than expected and the chances of a rate hike in May have now been completely discounted. Accordingly the Canadian dollar softened. Its move lower was helped by an overall weaker equity market. Tuesday sees the monthly inflation number released , followed by Retail Sales on Friday.

Sam Coxhead

Global Currency Payments & Transfers

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