by Darrell Jobman, Editor-in-Chief

UK retail sales rose 0.8% in July for a 2.1% annual increase, but this did not provide a sustained boost to confidence in the economy, especially as the June data was revised down. Second-quarter GDP was also revised down to a 0.0% from the 0.2% reported originally.

Minutes from the Bank of England’s August meeting recorded a three-way split for the second successive month. The majority wanted to leave rates on hold while Blanchflower voted for a cut and Besley for an increase. The bank was generally gloomy over its assessment of the economy and markets were still expecting interest rates to be cut before the end of 2008.

The UK currency remained under heavy selling pressure early in the week with a further test of support near 1.85 against the dollar, the weakest level for 22 months. Sterling pushed back towards 1.88 late in the week as the dollar, but weakened sharply again on Friday and dipped to lows near 0.7980 against the Euro.

US Dollar Index
Source: VantagePoint Intermarket Analysis Software

The dollar pushed to an eight-month high on a trade-weighted basis over the week, but the currency was increasingly vulnerable to a technical correction following rapid gains and dipped sharply on Thursday with the sharpest one-day decline for a month with a dip to 1.49 against the Euro.

There was further evidence of a reduction in carry trades funded through the yen which helped underpin the Japanese currency at times, but there was also a steady flow of funds out of the yen.

The Bank of Japan left interest rates on hold at 0.50% by a unanimous vote following the latest council meeting. The central bank also downgraded its outlook of the economy in its latest monthly report and there was some market speculation that the Bank of Japan would consider a cut in interest rates over the next few months.

The dollar was again unable to sustain gains above the 110.0 level against the yen and the Japanese currency pushed to highs around 108.10. The yen quickly retreated from the best levels as fresh selling emerged.

Trends in commodity prices were again very important in the currency markets over the week, especially with little in the way of major US economic data releases.

After a period of renewed strength, the US currency lost ground on Thursday as oil and gold prices rallied strongly. There were also renewed fears over the financial sector as the mortgage-finance agencies remained under pressure. The rally in commodity prices triggered a recovery in the Australian dollar and the Canadian dollar also strengthened to 1.0420 against the US currency before some consolidation.

The US housing data recorded a decline in hosing starts and building permits for the month with starts at a 17-year low, reversing the advance seen the previous month which had been triggered in part by a change in building regulations.

The US Philadelphia Fed index improved to -12.7 in August from -16.3 the previous month while the prices component was significantly weaker as commodity prices fell. Jobless claims fell to 432,000 in the latest week from a revised 445,000 the previous month, although this was still at an elevated level.

Producer prices recorded a further strong increase of 1.2% for July after a 1.8% increase the previous month while core prices also rose 0.7% over the month. There was little change in interest rate expectations with markets putting the chances of a rate increase this year at around 20%.

The German ZEW business expectations index recorded a recovery to -55.5 in August from -63.9 previously, but there was a decline in the current conditions index. The PMI index for the manufacturing sector weakened to just below the 50.0 level for August while the French data continued to deteriorate. The wider Euro-zone PMI releases provided some relief as they were above expectations, although both were still significantly below the 50.0 level.

The trade account recorded a seasonally-adjusted deficit of 3.0bn for June after a EUR1.0bn shortfall the previous month, maintaining the recent trend for deterioration, and the current account also remained in deficit.