By Darrell Jobman Editor-in-Chief

The dollar secured a net corrective tone following sharp losses the previous week and settled around 1.46 against the Euro in very nervous trading.

The Japanese currency retained a slightly weaker tone for much of the week as underlying risk aversion was at a reduced level. Tensions in the equity markets were lower which lessened near-term demand for the yen, but money-market tensions and uncertainty remained at an extremely high level. The yen strengthened towards 105.00 against the dollar late in the week as the US negotiations over the financial package hit difficulties. The Swiss franc also gained some support as stresses over the US bailout increased.

The UK housing data remained weak with BBA mortgage approvals falling to a fresh record low in August. The latest CBI retail survey recorded a further sales decline during September, although the decline was less than that seen the previous month.

MPC member Blanchflower reiterated his forecast of a further sharp rise in unemployment while he again called for a sharp reduction in interest rates. There were mixed comments from other MPC officials with both Sentence and Barker warning over the risks to growth and inflation.

The net balance of comments suggested that there were increased fears over economic conditions. Although uncertainty within and outside the MPC was high, there was increased speculation that there would be a move to cut interest rates at the October meeting.

The UK currency pushed to a 1-month high around 1.8650 against the dollar during the week, but then dipped sharply back towards 1.83. Sterling was also unable to sustain gains beyond 0.79 against the Euro with a retreat to 0.7960.

In view of the depressed data releases, markets moved to price in at least an 80% chance of an interest rate cut at the October FOMC meeting.

The German IFO index weakened further to 92.9 in September from 94.8 the previous month and the institute was generally pessimistic over prospects. The IFO staff also stated that the ECB should move towards a cut in interest rates.

The latest PMI releases recorded a further deterioration in conditions with the composite index dipped to the lowest level since 2001. The current account deficit narrowed over the month while there were further outflows on the capital account.

The ECB remained concerned over the inflation outlook and was continuing to focus on the secondary inflation risks surrounding wage developments. There was an increase in political pressure for a more accommodative monetary policy with Spanish Finance Minister Solbes calling for the ECB to move to cutting rates while the ECB also expressed greater concerns over the economy.

British Sterling
Source: VantagePoint Intermarket Analysis Software

Conditions within the US financial markets continued to dominate investor sentiment and currency trends for much of the week. The increasing mood of uncertainty contributed to choppy trading conditions and also made it difficult to secure a decisive trend.

Following the announcement late last week, the Treasury continued to push for congressional agreement over a US$700bn support package for the financial sector.

Political tensions increased later in the week with President Bush stark in his warnings over the severe negative impact if an agreement was not reached.

Money-market tensions remained extreme and global central banks aggressively provided liquidity to help ease these strains and allow markets to function.

Congressional leaders looked to be near a framework agreement on Thursday, but there were then fresh tensions as a group of Republicans looked to promote an alternative package amid acrimonious talks. There was no resolution by early on Friday.

Fed Chairman Bernanke was generally downbeat over the economic prospects and more pessimistic than in recent comments. He stated that growth would be likely to be substantially below potential over the second half of 2008. Market stresses could be a considerable drag while commercial real-estate loan conditions had tightened substantially. Bernanke also stated that recent inflation news had been slightly more favourable.

US Dollar Index
Source: VantagePoint Intermarket Analysis Software

There were only limited US data releases over the first half of the week. The pace of releases then picked up and had a generally weak tone. Existing home sales dipped slightly to an annual rate of 4.91mn from 5.02mn the previous month while prices were lower. The latest national survey also recorded a further decline in house prices.

The was a sharp 4.5% decline in durable goods orders for August while initial jobless claims continued to increase to 493,000 in the latest week. Although there may have been distortions from hurricanes, the evidence suggested an underlying deterioration.