Foreign Exchange
Sterling remains in a relatively narrow trading range against the dollar and euro. Friday’s US employment report presented a somewhat negative picture of the US labour market with the unemployment rate rising to 5.7% and the non- farm payroll falling by 51,000. Despite the increase in unemployment rate, the reduction in non farm payroll was less than expected and hence the reaction of foreign exchange markets to the US data was somewhat muted. There was also little reaction to the UK Chartered Institute of Purchasing and Supply Managers (CIPS) Index of manufacturing, which fell by 1.6 points to 44.3. This was the lowest reading since December 1998. Interestingly, UK growth in 1999 was 3.0%. Our view is that there will be an upturn in the UK economy in 2009. This prediction is compatible with the IMF forecast that the global economy will reach a trough in the final quarter of the year. There is often a strong correlation between the UK economic cycle and that the global economy. At present, the significant correlation between the UK economy and that of the eurozone and the USA, and the likelihood that UK base rate will remain on hold for some time, are key factors behind the relative stability of sterling on foreign exchange markets.
Interest Rates
This week there is a very substantial volume of key UK releases. These include the CIPS service and construction surveys, industrial production data, the Halifax price index and the MPC meeting. There is a very high probability (80%) that base rate will remain unchanged at 5%. Given the 7-1-1 split at the last MPC meeting, there is an equal 10% probability of a quarter point decrease and increase. The MPC will undoubtedly focus on the downturn in UK growth to 0.2% per quarter and the rise in CPI to 3.8% per annum, plus the prospect of further negative inflation and growth data in the next few months. The MPC are walking a monetary policy tightrope and will probably take the shortest policy route – an unchanged base rate until at least year end. We expect to see a degree of volatility in period rates this week given the large volume of key UK data and the intra day volatility in the equity markets.
Equities
World equity markets remain in volatile mode, with an underlying moderate bear trend. We sense that the scale of the intra day fluctuations indicates that we approaching the end of an equity market cycle, and that in the fourth quarter a new bullish trend will emerge. This factor is less obvious from a UK perspective. The FTSE fell by 4% last month versus a 1% decline in the Standard & Poors 500 and a ½% decline in the Eurostoxx 50. A key factor behind FTSE underperformance was the decline in oil prices, which if sustained would be positive for global growth prospects.
Oil and other commodities
Brent crude (1 month forward) last week traded in a $122-127 trading range. Over the next two weeks, we expect Brent to trade in a range circa $120-130/ bl, in the absence of any major disruptions to supply.