FOREX TRADING

The Euro and the British Pound tested higher in Asian trading but failed to retain momentum, retreating versus the Greenback ahead of the UK Consumer Price Index and German ZEW survey of investor confidence due in European hours.

Key Overnight Developments

• RBA Weighs Risk of ‘Choking’ Demand If Rates Rise Too Soon

• Euro, British Pound Try Higher But Fail to Build MomentumCritical Levels

The Euro corrected higher in Asian trading but the bulls failed to retain momentum, with the pair stalling near 1.41 ahead of the opening bell in Europe. The “Cable” British Pound also tested higher to test as high as 1.6394 but reversed course late into the overnight session, yielding an effectively flat result.

Asia Session Highlights

The Reserve Bank of Australia said there is a “risk of an early tightening choking off confidence and demand prematurely” if it raises its benchmark policy rate too soon. There’s a few question as to whether recent improvements have been organically produced or if they’ve come on the back of fiscal stimulus. Indeed the bank weighed this scenario, saying that “a particular source of uncertainty was whether the recent growth in household spending was due mainly to the irregular fiscal measures,” which would soon fade, or “a more general decline in risk aversion.” Indeed, the bank does have a legitimate reason to worry. While Q2 spending rose by the most in almost two years, the monthly June figure plummeted 1.4% in spite of anticipations for an increase in retail sales of 0.5%. This downward trend is probably to continue, the bank said. In fact, their “staff liaison with retailers recommended that spending in July might be weaker than in earlier months.”

The quick turnaround in rhetoric contrasts that from which RBA Chief Glenn Stevens stated at a testimonial last week. In his comments, the 51-year old said that the bank would indeed raise the “emergency” level overnight cash rate once the economy began to show clear signs of recovery. More significantly, the RBA had revised it’s 2009 GDP estimate significantly upward. Details released on August 7, revealed that the bank expects the Australian economy to grow by 0.5% this year – quite a contrast from the -1.0% economic contraction that had been originally expected. However, the bank maintains that a strong recovery in Asia will stabilize global output. Australia’s economy is still anticipated to grow in 2009.

Euro Session: What to Expect

July’s UK Consumer Price Index is anticipated to show that inflation shrank for the first month since January when the annual pace of price growth slowed to 1.5%, the lowest in over 4 years. The Bank of England has said that CPI will fall below 1% at some point in the third quarter in its quarterly inflation report published last week. From there, Mervyn King and company anticipate inflation to be “unusually volatile”: upward pressure is seen as past changes in energy prices drop out of year-on-year comparisons and from firms’ continued adjustments to a weaker British Pound (as compared to the peak in late 2007); in the meantime, downward pressure is seen as rising unemployment depresses wages. The central bank concluded that “inflation is more probable to be below [the 2% target level] in the medium term [than above it]”. On balance, this broad accounting of what to anticipate in the coming months suggests that, barring a wild deviation from the estimate, the CPI result is unlikely to prove substantially market-moving having probably been priced into the exchange rate at this point. Indeed, with interest rates already at 0.5% and a 175 billion pound quantitative easing scheme firmly in place, lending growth figures (showing the degree to which aggressive easing is filtering into the broad economy) are far more significant to gauge future monetary policy than inflation data.

Turning to the continent, Germany’s ZEW Survey of investor confidence as well as the broader Euro Zone equivalent are both seen ticking higher in August, returning to levels seen in June after unexpeectedly turning lower in July. Last week, an analogous metric from the Sentix research institute ticked to the highest level in a year, with the accompanying statement saying that “the economic recovery is now being ‘discovered’ by a broader group of investors.” Still, a survey of economists polled by Bloomberg reveals that most market-watchers expect the Euro Zone to underperfrom the spectrum of industrial economies next year, so any optimism born of growing confidence that an armageddon scenario has likely been averted seems temporary at best, with European sentiment figures likely to head lower as analysts focus on questions of who will recover first.

Written by Ilya Spivak, Currency Analyst with Luis Gil, DailyFX Research