Financial crisis, equity market losses and short sellers have all but dominated the markets this week. The gains made by the pound versus the dollar last Friday, on the back of weak US retails sales data, were completely erased when Lehman Brothers became the latest casualty of the credit crunch. The bank filed for bankruptcy on Monday leaving behind a trail of panic as investors fled risky positions. Insurance giant AIG further fueled the panic as it came close to collapsing before a bailout package was announced by the U.S government. The result of all this market turmoil was higher gold prices, a surging dollar and the unwinding of so called carry trades as investors scrambled for safe havens. Traditional funding currencies for carry trades, namely the Swiss Franc and Japanese yen, both made significant gains across the board. Locally concerns over the financial health of HBOS hit the markets and placed pressure on sterling.
While economic data was largely overshadowed by these events it wasn’t completely ignored. UK CPI data came out higher than expected at 0.6% m/m while the RPI index came out at 4.8% y/y. Markets glanced over the release but focus was on the BoE’s Inflation letter to the Chancellor of the Exchequer. In the letter Governor King stated that the MPC was firm in its belief that a period of economic weakness is needed to bring inflation back down. This statement and the minutes from the last BoE MPC meeting did little to alter the markets view on monetary policy. The minutes revealed an 8-1 vote to keep interest, Blanchflower being the only dissenter voting for a 50 basis point cut. The outlook on inflation by the BoE has not changed and the MPC are still in a neutral stance on monetary policy, but it is unclear how much longer this can be maintained.
The pound managed a mid-week rally as a merger was announced between Lloyds and HBOS to prevent the bank from failing. The announcement coupled with higher than expected retail sales data saw sterling hit 2 week highs versus the buck.
While sterling had a volatile trading week against the U.S dollar, versus the euro consistent gains were made. Data in the eurozone was largely mixed but a significantly weaker German ZEW economic sentiment report sparked large gains for the dollar and allowed the pound to benefit as well. UK retail sales data further enhanced the pound position as it now trades near 1 month highs against the euro.
Next Week:
Markets will be paying close attention to equity markets and financial stocks as investors remain wary of further troubles within the financial sector. With some calm having returned to markets trader may be more interested in data releases with a full calendar of market events available for the week.