Foreign Currency
Sterling is broadly unchanged against the major currencies ahead of two key announcements today – the ECB repo rate decision and the US employment report. The ECB decision could well have a major bearing on the £/ euro rate and future UK interest rate policy. We predict that the ECB will increase the repo rate to 4.25% given the strong anti inflation rhetoric of the ECB Governor and the fact that EU inflation is way above the 2% target. A repo rate increase is largely discounted by foreign exchange markets and the path of euro/ sterling will be determined largely by the ECB statement and subsequent press conference comment which will provide a guide to the future path of eurozone repo rate. The consensus forecast for US data is a marginal fall in the unemployment rate and a reduction in non- farm payroll. The data is taken from two separate reports that do not always provide a consistent picture. The labour market statistics could have a significant bearing on the future path of the dollar if significantly different from consensus forecast. Foreign exchange activity will be more subdued tomorrow – US financial markets will be closed for the July 4th holiday.
Interest Rates
Period rates (2 years plus) are broadly unchanged despite negative UK survey data. The Chartered Institute of Purchasing and Supply Managers (CIPM) construction survey showed a 5 point fall in the overall index to 38.8. The housing component was by far the weakest element of the survey. One positive aspect was the strong reading of 57.8 in respect of future construction business expectations. There is likely to be a very substantial volume of infrastructure work in the UK over the next 10 years. Today sees publication of the CIPM services sector index. The private service sector represents 50% of UK economic output. The ECB meeting today has special significance. A repo rate increase would put severe pressure on the MPC to consider a base rate rise next week. The US labour market report could well have a bearing on longer term rates. The data will provide clear evidence as to the scale of the US slowdown and the probability of the US entering recession. Whilst the data is expected to be weak, we believe that it will be compatible with US growth remaining in positive territory, albeit at a rate uncomfortably close to zero.
Equities
World equity markets closed lower. The underlying trend remains bearish given that the credit crunch is currently exerting its maximum impact at a time when the European Central Bank is seriously contemplating a repo rate increase. We believe that longer term fixed interest rates will reach a peak in the fourth quarter after which asset managers will are likely to focus on the more positive sectors of the equity market.
Oil and other commodites
Brent crude (one-month forward) is trading in the region of $145 / barrel. A recent significant development was the publication of the International Energy Agency Medium Term Report. The IEA predicts that the tight balance between oil supply and demand will ease marginally in 2008-10, as new supply comes on stream and as the rate of global economic growth slows. From 2011 onward, the IEA expects the position to be reversed, with much stronger global demand and a reduction in the rate of growth of new capacity.