by Darrell Jobman, Editor-in-Chief TraderPlanet.com
The dollar found further support close to 1.38 against the Euro during Tuesday, but was unable to make any significant headway in cautious trading.
US producer prices fell 0.2% in June, but there was a 0.3% increase in core prices, suggesting some underlying inflation pressure. The consumer inflation data will be watched closely on Wednesday and an elevated reading for core prices would increase Federal Reserve unease over underlying inflation trends, especially as energy prices have risen strongly since the June data was compiled.
The industrial production data was solid with a 0.5% June increase while manufacturing output rose 0.6% and capacity use increased to 81.7%. The industrial sector should remain strong in the short term, but concerns over the housing sector will persist, especially as the NAHB housing-market index fell to 24 in July from 28 previously, the lowest reading for 26 years.
Given uncertainties over economic direction, comments from Fed Chairman Bernanke will be watched closely on Wednesday. If Bernanke focuses on the inflation risks then the dollar will tend to gain ground while greater concern over the housing sector would tend to undermine the US currency.
The German ZEW index fell to 10.4 in July from 20.3 which will maintain expectations of a Euro-zone slowdown and curb Euro enthusiasm slightly.There will be particular concern over the outlook for economies outside Germany given that competitiveness has weakened sharply.
The yen was unable to strengthen through the 121.50 level against the dollar on Tuesday and weakened back to 122.35 in US trade as the currency was subjected to renewed selling pressure on the crosses.
The levels of risk aversion are still having an important currency impact. The yen gained ground as European stock markets fell, but these gains were reversed as markets recovered later in the session.
The Japanese services-sector growth index dipped 0.1% in May with a 1.3% annual increase which will not increase confidence in the Japanese economy or give the Bank of Japan additional reason to increase interest rates in August. Although the most likely outcome is still that rates will be increased, markets will remain cautious. Any evidence of government defeat in the Upper-House elections later this month would dampen expectations of a tougher Bank of Japan stance.
After holding above 2.0350 against the dollar in early Europe on Tuesday, Sterling strengthened to highs close to 2.0470 after the inflation data. The UK currency also pushed to 0.6735 against the Euro.
UK Consumer prices rose 0.2% in June, cutting the annual rate to 2.4% from 2.5%, although markets were expecting a larger fall to 2.3%. Core inflation rate rose to 2.0% from 1.9%, the highest figure for 10 years, while the Retail Prices inflation rate increased to 4.4% from 4.3%.
The higher than expected inflation data will maintain expectations that the Bank of England will be forced to raise interest rates further to curb inflation pressure.
The Bank of England July minutes and earnings data will be watched closely on Wednesday for further evidence on inflation pressure.
Futures markets have now priced in around a 70% chance that interest rates will rise to 6.25%. There will, however, be increasing concerns that the economy will weaken sharply if rates are increased to this level.
After strengthening to 1.6525 against the Euro on Tuesday, the franc was unable to hold the gains and weakened back to 1.6570. The dollar fluctuated around the1.20 against the Swiss currency with rallies still encountering selling pressure.
The franc gained support from an initial increase in risk aversion, but buying interest weakened as European stock markets recovered. Short-term Swiss currency moves will remain strongly correlated with levels of risk aversion.
The Swiss economic data was strong with retail sales rising an adjusted 7.2% in the year to May from 3.2% previously. The National Bank will retain a tightening policy bias and there is still the possibility of another increase in rates before the scheduled September meeting.
The Australian currency strengthened to 0.8750 in early Europe on Tuesday as confidence remained strong, but the currency drifted back to 0.8730 in New York as profit taking set in.
There were no major domestic incentives with a drop in imports not having a significant impact. There is still strong global interest in high-yield currencies which is providing firm Australian dollar support, especially with commodity prices still generally robust. There is still the risk of a sharp correction given the extent of recent gains.