by Darrell Jobman, Editor-in-Chief TraderPlanet.com
The Euro remained under pressure in European trading on Wednesday with lows around 1.3460 before a fragile recovery to 1.3490. The Euro was unable to sustain the gains and slipped back to 1.3450 later in US trading as Wall Street slipped again.
Risk aversion continued to dominate for much of Wednesday. The dollar gained support from a further covering of short positions, an asset shift away from the Euro and further flows into the US bond market. These pressures were enhanced by the fact that emerging-market currencies came under some pressure with the Brazilian real, for example, weakening to three-month lows.
Headline US consumer prices rose a subdued 0.1% in July while the underlying increase was 0.2% to give an annual increase of 2.2%. Given the core rate, the Federal Reserve will still not be able to relax over inflation trends, but markets are still expecting an interest rate cut by October to ease credit-related difficulties.
Long-term capital flows dipped to US$120.9bn for June from a revised US$126.0bn the previous month, but this is still an historically high figure. Total capital flows weakened to US$58.8bn for the month and the July data will be watched very closely, especially as escalating credit difficulties are likely to have undermined corporate bond inflows.
The yen strengthened to highs around 116.65 against the dollar, the strongest level since March, while the Japanese currency also strengthened sharply to highs of 157.0 against the Euro. After weakening in late European trading, the yen regained ground later in US trading as underlying support continued with volatility remaining high.
The yen has gained further support from increased risk aversion with a continuing asset reallocation into more defensive currencies. The underlying stresses are liable to persist even if there are intermittent recoveries in risk appetite and there is still the risk of a more disruptive closing of carry trades.
The latest Japanese monthly economic indicator suggested a deterioration in the services sector while the manufacturing sector held firm. Markets have cut the chances of an August Bank of Japan interest rate increase to around 30% and reduced expectations of an increase will tend to weaken the yen if markets stabilise.
Sterling weakened to lows near 1.9850 against the dollar on Wednesday, the weakest level since late June before staging a slight recovery to 1.9920. The UK currency strengthened to near 0.6755 against the Euro.
Minutes from the August Bank of England MPC meeting revealed a 9-0 vote for unchanged rates while the bank expressed some concerns over underlying credit risks and there was no discussion of a back-to-back rate increase.
The overall tone of the minutes was weaker than might have been expected, especially as it tends to contradict the inflation report released after the meeting. This suggests a lack of confidence in the bank’s internal forecasts.
The headline earnings growth slowed to a three-year low of 3.3% in June from 3.5% previously. The combination of MPC minutes and weak data will continue to lower interest rate expectation and the impact will be enhanced if there is a weak retail sales report on Thursday. The shift in interest rate expectations will continue to undermine Sterling.
The Swiss currency has continued to drift weaker against the dollar with lows around 1.2190. The Swiss currency was again struggling to hold gains beyond 1.64 against the Euro, but found support close to 1.6430.
Levels of global risk aversion remained the dominant influence over the past 24 hours. Although the franc has gained support from underlying stresses, it has underperformed the yen which suggests that markets are shying away from European currencies in general.
The retail sales report was much weaker than expected with the annual increase held to 1.0% in June. The monthly data is, however, erratic and there was a firm 4.9% increase for the first six months of 2007.
After weakening sharply in late US trading with losses extending to 0.8245 in local trading on Wednesday before a fragile recovery.
The domestic economic data failed to have a significant impact as markets continued to focus on credit risks and a sharp drop in Asian stock markets helped push the Australian dollar weaker. The more defensive stance will continue to undermine the Australian currency in the short term, especially if there is an escalation in Asian emerging-market currency losses, but the currency recovered slightly from lows near 0.82.