Despite questions about how the European bank stress tests were conducted, investors seemed satisfied enough with the results early Monday morning to underpin the Euro while waiting for fresh news regarding the U.S. housing market.
Following the release of U.S. new home sales data which saw an increase in June by more than economists had forecast, the Euro rallied and is now pressing a minor .618 retracement level at 1.2998. This puts this pair in a position to challenge last week’s high at 1.3028.
Stocks extended their gains following the housing report, driving up demand for higher risk assets, helping the Euro maintain the upward momentum which helped drive the market higher late last week.
The British Pound finished higher but momentum slowed when the market neared a weekly swing top at 1.5523. A breakout over this level will turn the main trend up and set up a possible acceleration to a major 50% retracement level at 1.5635.
Fundamentally the Sterling is being driven higher by last week’s release of better than expected second quarter GDP. Last week’s news – that the U.K. economy expanded by a strong 1.1 percent – was a sign that the economy was more stable than previously estimated. This news led some investors to believe that the Bank of England will have to seriously consider raising its benchmark interest rate sooner than expected.
As the Pound approaches a key retracement level at 1.5635, investors have to realize that the second quarter expansion took place before the government implemented its proposed deep spending cuts and tax hikes. The biggest fear amongst bullish traders is that the government’s proposed austerity measures will curtail the gains that the economy is currently showing.
The Australian Dollar surged on Monday as rising equity markets drove up demand for higher yielding assets. Traders are also chasing the higher yield in Australia due to the weaker outlook for the U.S. economy.
Early Monday morning, the Aussie’s rally slowed a bit due to a disappointing Producer Price Index report. The PPI rose 1.0% compared with a forecast 1.5% rise. After a slight retreat from the early session high, the market regained its momentum to test .9000 in the U.S. session for the first time since the middle of May.
Although initially concerned with the modest gain in the PPI, traders quickly turned their focus on Wednesday’s Consumer Price Index. Traders are looking for this report to show an increase of 0.8%, keeping in line with the Reserve Bank of Australia’s overall target band of 2% to 3%. A report greater than the estimate could be the trigger which gives the RBA a reason to hike its benchmark rate once again at the next policymakers meeting on August 3.
The RBA has been on the sidelines since May, choosing to ignore the economy over the short-term because of the financial problems in Europe at the time. Now that it seems that the European financial system is sound, the RBA will shift sentiment back to the economy. The Australian economy has been strong but traders will have to decide on Wednesday whether it has been strong enough to warrant another rate hike based on the inflation data. A spike in consumer prices will put inflation over the target band, setting the table for a 25 basis point hike to 4.75%.
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