by Darrell Jobman, Editor-in-Chief

Although the US economic conditions remained an important focus, the state of the world economy attracted much greater attention and this triggered sharp currency moves as there was a potentially important turn in sentiment. Fears over international conditions curbed selling pressure on the US currency with a particular focus on Europe.

There was a further dip in retail sales for June with the annual decline at a record 3.1% as income levels continued to stagnate. The Euro-zone Sentix index also weakened to -15.3 in July from -9.3 and this was the lowest reading for over five years. The PMI services sector index was also confirmed at a five-year low for July.

There was a sharp decline in German factory orders for the June while there were also reports of a 1.0% GDP contraction for the second quarter although this followed a strong reading for the first quarter.

As expected, the ECB left interest rates at 4.25% at the latest council meeting. In the press conference, President Trichet reaffirmed that the bank would take a firm tone on inflation. Trichet also remarked that growth had slowed substantially over the middle of 2008 as risks had materialised. Markets tended to focus on the growth comments which helped spark a rally in bond prices and also weakened the Euro sharply.

The US currency was also underpinned by a sharp decline in commodity prices over the week as fears over a decline in demand put downward pressure on prices.

The US PMI index for the services sector rose to 49.5 from 48.2 previously while the underlying components were mixed. There was a recovery in the employment index, but inventories rose which suggests that growth will be weak in the short term.

The labour-market data remained weak with initial jobless claims rising to a fresh five-year high of 455,000 in the latest week, the second successive reading above 420,000. The figure is likely to have been inflated again by a change in the qualifying rules, but unease over the labour market persisted.

US Dollar Index
Source: VantagePoint Intermarket Analysis Software

The core PCE index recorded a 0.3% increase for June while the annual rate rose to 2.3%. This is significantly above the Fed’s 1-2% target range.

As expected, the Federal Reserve held interest rates at 2.00% following the latest FOMC meeting. There was a 10-1 vote with Fisher again dissenting and calling for a hike in rates to curb inflation expectations.

The statement was not changed radically from the previous meeting with the Fed uneasy over both growth and inflation aspects. The inflation situation was described as highly uncertain with considerable concern while the labour market had softened further. There was no major impact on interest rate expectations.

The dollar again secured a firmer tone over the week and strengthened to a 6-month high on a trade-weighted basis while also pushing through June’s highs against the Euro with gains to near 1.51.

Japanese government officials downgraded their assessment of the economy and warned that the economy could be in recession which undermined sentiment. With the US currency also generally firmer, the yen weakened to the lowest level against the dollar since January with a dollar challenge on 110.0.

The sharp decline in commodity prices undermined the Australian and Canadian dollars over the week. The Reserve Bank of Australia left interest rates on hold at 7.25% at the latest policy meeting, but the bank also suggested that rate cuts may be required over the next few months. The switch to an easing policy bias helped trigger heavy currency selling, especially with evidence of weakness in the housing sector. The Australian currency weakened to 6-month lows below 0.90 against the dollar while the Canadian dollar also weakened to beyond 1.06.

The UK PMI services index edged higher to 47.4 for July from 47.1 previously, but this was the third consecutive figure below the pivotal 50.0 level. The construction PMI index also weakened to a record low of 36.7.

The IMF issued a downbeat report over the economy, cutting GDP growth forecasts for the next two years, and also warned that Sterling was liable to fall further.

The Bank of England held interest rates at 5.00% for the fourth successive month at the latest policy meeting. There was no statement following the meeting and the vote breakdown was also not announced.

Sterling weakened to a 17-month low against the US dollar with lows close to 1.92 on Friday.