Markets Remained in an Extremely Cautious Mode

EUR/USD

The Euro found support on dips towards the 1.2530 area on Wednesday and pushed higher during the session as markets looked to make a challenge on resistance areas above 1.2580.

ECB President Draghi stated that the ECB may be required to take exceptional measures to ease the Euro-zone crisis and there were further expectations that the central bank would look to engage in a fresh bond-purchasing plan following the September ECB meeting.

Markets and indeed Draghi were also aware that the room for manoeuvre was relatively limited given the high degree of scepticism surrounding the plans within the German government and Bundesbank. There will need to be a very fine balancing act between satisfying market demands while not provoking Bundesbank censure which would tend to destabilise the Euro. This lack of flexibility was important in curbing optimism surrounding the potential ECB plans despite expectations that some measures would be introduced.

There was also some evidence of divisions between German Chancellor Merkel and Italian Prime Minister Monti in talks on Wednesday with Merkel, for example, rejecting the possibility of a banking licence for the ESM and underlying tensions remained high.

The revised US second-quarter GDP data was in line with expectations at 1.7% from a provisional 1.5% while the pending home sales data was stronger than expected with a 2.4% gain to a three-year high. The latest Fed Beige Book reported that the economy was expanding gradually while there was evidence of some softening in manufacturing activity.

Markets remained in an extremely cautious mode ahead of Chairman Bernanke's speech on Friday. The Euro was unable to make a serious challenge on resistance while there was support on dips to the 1.2520 area.

Yen

The dollar found support on dips to just below the 78.50 level against the yen on Wednesday and pushed generally higher during the New York session with a peak near the 78.80 area. The US housing data had a positive impact on yields and sentiment which helped underpin the US currency.

There were concerns surrounding political stresses with expectations that the opposition would block discussion on government-financing legislation which could block government funding later in the fourth quarter. Following a downgrading of the government's economic outlook, there were further expectations that the Bank of Japan would take additional policy action during the fourth quarter and the retail sales report was weaker than expected.

There were still important reservations surrounding any aggressive selling of the yen and the dollar edged back to the 78.60 area during Asian trading on Thursday.

Sterling

Sterling found initial support on dips towards the 1.58 area during the European session on Wednesday and pushed to a high near 1.5850. After a sharp retreat, Sterling was able to rebound later in New York as it held support on dips towards 0.7950 against the Euro.

There were no major UK developments during the day as markets remained focused on US and Euro-zone policy judgements and potential action during September. The Bank of England is likely to be on hold at the September meeting which will keep the focus on international developments.

There will still be concerns that the UK economy could lose its AAA credit rating in the medium term which will tend to limit buying support even though, for now, it is still a background rather than acute threat.

Swiss franc

The dollar found support on dips towards the 0.9550 area during Wednesday and advanced gradually to the 0.9590 area as underlying ranges were generally very narrow. The Euro remained trapped close to the 1.2010 area.

The KOF index strengthened to 1.57 in the latest month from a revised 1.41 previously which should lessen fears surrounding the economic outlook to some extent, although the National Bank will still be concerned surrounding the potential deflation threat which will maintain pressure for franc gains to be resisted.

Australian dollar

The Australian dollar found support on dips to the 1.0350 region against the US currency on Wednesday and briefly pushed haply higher to a peak near 1.04. The US data did provide some degree of support and there was also some suspicion of Australian dollar buying by the Swiss National Bank.

There was a much weaker than expected reading for building approvals with a 17.3% decline for July which maintained unease surrounding the domestic economy and there were continuing fears surrounding falling iron ore prices which pushed the currency to one-month lows below 1.0320 before a limited correction.

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