FX market mulls UK and US rate moves

Rate rises - both actual and the discussion of - dominated foreign exchange markets on Tuesday as the Federal Reserve raised rates by the expected quarter point and data led investors to reconsider their projections for interest rates in the UK.

The dollar managed a short-term dip after the Fed’s announcement, which took the Fed funds rate to 1.5 per cent. The euro rose to $1.2319 before settling back to $1.228, its level before the news. The Fed maintained its pledge of “measured” rate rises but was more bullish on the economic outlook than some had expected.

But sterling was the big loser after a triumvirate of weak economic updates pushed the pound to centre stage. Shortly after the Fed’s announcement, sterling was at $1.834 against the greenback, down from more than $1.84 in London morning trade.

UK consumer prices fell 0.3 per cent in July, dragging the annual rate down to 1.4 per cent, well below both the 1.6 per cent recorded in June and the 2 per cent rate targeted by the Bank of England.

With the British Retail Consortium also reporting a fall in like-for-like sales growth to 1.8 per cent in the year to July, from 2.4 per cent in June, some concluded that the pace of UK monetary tightening was set to ease.

“With retailers finding it increasingly difficult to get customers and therefore raise prices, we believe that inflation will continue to undershoot 2 per cent for the foreseeable future,” said James Knightley at ING Financial Markets.

The data “should deter the MPC from making back-to-back [rate] increases,” said Tim Fox at National Australia Bank, who added that further rate hikes were likely if the UK output gap had closed, as NAB believes.

However, Howard Archer at Global Insight did not rule out a September hike, seeing consumer borrowing and the housing market as key. In addition, the UK’s trade gap widened to £4.97bn in June from £4.83bn in May, confounding expectations for a narrowing and raising questions about its long-term funding.

The yen was also soft as Toshihiko Fukui, the governor of the Bank of Japan, said a change in the Bank’s zero interest rate policy was “nowhere in sight”. Further, Mr Fukui said higher inflation alone would not be enough to bring about any change in monetary policy, with wider economic expansion also necessary. He also raised concerns about high oil prices.

“The comments clearly indicate that despite the signs of improving economic conditions, the Bank of Japan is still some way from changing the current monetary stance,” said Derek Halpenny, senior currency economist at Bank of Tokyo-Mitsubishi. “That fact will help reinforce investor outflows from Japan.”

The yen eased 0.4 per cent to Y136.33 to the euro.

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