Sterling's Olympian Dive

The following was posted on August 13, 2008.

The dollar regains composure following a brief retreat following the US retail sales report, but the tumbling pound remains the headliner in foreign exchange markets.

US retail sales drop 0.1% in July, showing the first decline in 5 months, bringing into focus the fading effect of the government stimulus package. The rise was better than consensus forecasts showing a 0.4% decline. The 0.4% increase excluding autos rose 0.4% was within expectations, but follows 0.8%, 1.2% and 1.1% in the prior 3 months. Meanwhile, US import prices jumped 1.7% last month, following a revised 2.9% increase in June. The figure is expected to show a substantial slowdown in comings months due to dollar strength and oil weakness.

The British pound continues to plummet across the board as the Bank of England appears increasingly out of options in bringing down inflation from its 15-year highs while unemployment rises the most in 16 years. The central bank slashed its Q1 2009 GDP growth forecast from 1.0% to 0.1% and conceded that a technical recession is an increasingly strong possibility. Sterling tumbled 2 cents against the dollar on the day, amounting to a 5.6% decline so far this month, while shedding 5% against the yen over the same period.

Todays release of the Bank of England would have pushed sterling higher in normal conditions, but the accompanying gloom for UK fundamentals dragged the currency across the board. The BOE said annual inflation will peak at 4.8% by the start of 2009 before falling down to 1.8% in 2010, based on assumptions for interest rates remaining unchanged at 5.0%. But the inflation report was released alongside unemployment figure showing the 6th straight monthly increase, with the jobless rate climbing to 2.7% from 2.6%, the unemployed count rising by the most in 16 years and wages growing at the slowest pace in five years.

Our long established bearish stance on the pound has long been highlighted by our forecast that the currency would become the dollar of 2008, underperforming as poorly as did the dollar in 2007. The escalating repercussions of the UK housing recession and banking losses are to make BoE rate cuts a foregone conclusion, despite inflation being at a 15-year high of 4.4% And finally with interest rates remaining at 5.00% means that the downside potential for rates remains most ample in the G7.

Tumbling to a fresh 21 month low of $1.8733, GBPUSD nears the head and shoulder formation target from the 2.116 high (head) to 1.96 (neckline), paving the way for 1.86.

Euro Seen Supported by Slower US Sales

Euro gains further ground as the 0.1% decline in US July retail sales is the first time in 5 months, leading to rising speculation that post-stimulus consumer spending will return below zero. The euros 2-pence jump against the pound over the past 2 days is helping the single currency stabilize against the dollar around the $1.4850s, which is well above the widely recognized support level of $1.47. ECB policy makers are increasingly stating that a sharp slowdown in Q2-Q3 growth is a normal give back following the substantially strong Q1 GDP, thus likely to result in annual 2008 growth matching expectations of 1.7%. EURUSD regains the $1.4920s, eyeing the $1.4960 resistance, but renewed pressure is expected at $1.50. Support stands at $1.4860. The ensuing positive correlation between US stocks and the dollar also bears watching for the latest developments in FX.

USDJPY Dips to 1-week Low The dollar drops by a full yen to 108.50, posting its third consecutive decline as the previous run-up appeared increasingly a result of momentum traders rather than fundamental developments. Economic weakness is not limited to Japan , but consistent revelations of new writedowns by US banks and renewed consumer erosion following the conclusion of the stimulus package is likely to send USDJPY back towards the 106.50s followed by 104 by month end. We reiterate that renewed bout of reduced risk appetite is expected to accelerate the yens appreciation, particularly against the USD, GBP, CAD and NZD. USDJPY seen capped at 108.80, followed by 109.20. Support stands at 107.80.