Weekly Review July 17
The main theme during the week was expectations that central banks outside the US would move to remove policy accommodation. This shift in relative expectations was important in undermining the dollar.
The Bank of Canada actually moved to raise interest rates while the ECB edged extremely slowly towards removing some accommodation.
Expectations of less accommodative policy elsewhere and disappointing US data weakened the US dollar during the week.
Federal Reserve Chair Yellen faced the six-month grilling in Congress as she testified on the economy. Yellen continued to expect interest rates to rise gradually, although she was also cautious surrounding inflation.
There was no major fresh evidence with market expectations of one further interest rate increase before the end of 2017.
The retail sales data was weaker than expected with a headline decline of 0.2% for June and underlying sales also fell on the month.
The CPI inflation data was below expectations with prices unchanged on the month and the year-on-year increase was held at 1.6% from 1.7% previously.
What does this mean?
The weaker than expected data on retail sales and consumer prices dampened expectations that the Federal Reserve would continue to increase interest rates and also triggered a fresh round of selling pressure on the dollar. The dollar index weakened to below 95.0 and the lowest level for over 10 months.
Uncertainty surrounding the UK political and economic outlook remained a key focus during the week.
The unemployment rate declined to a 32-year loss of 4.5% while the rate of growth in average earnings remained subdued at 1.8%.
Bank of England MPC member McCafferty continued to indicate that he would vote for a rate increase at the August policy meeting. In contrast, bank Deputy Governor Broadbent suggested that he was not yet ready to raise interest rates.
There was further evidence of divisions over Brexit policy and speculation that the government strategy would be blocked within parliament. There were also persistent reports of splits within the government.
Sterling gained support from confidence in the global growth outlook and higher commodity prices, although dollar weakness was the main trigger for gains.
There was a reluctance to sell Sterling aggressively given that it remains substantially undervalued while there could be a move to raise interest rates and the dollar also lost wider support.
Sterling gained support after a convincing break of the 1.3000 resistance area in GBP/USD which triggered highs near 1.3100 late on Friday. EUR/GBP retreated to the 0.8750 level after hitting 8-month highs around 0.8900 earlier in the week.
There were source reports from the ECB that the central bank was likely to announce a reduction of its bond-purchase programme at the September meeting. There were also reports that the ECB was reluctant to signal any precise date for ending the bond-purchase programme.
Expectations that the ECB would eventually move to increase interest rates provided key support for the Euro.
The central bank remains concerned that any move to end emergency measures will put strong upward pressure on bond yields and push the Euro sharply higher.
The Euro made net gains and EUR/USD closed above 1.1450, although the currency failed to hold its best levels on the crosses.
The Bank of Canada increased interest rates to 0.75% from 0.50% at the latest monetary policy meeting. Although a majority of forecasters expected a rate increase, a sizeable minority expected no change. The Canadian dollar strengthened sharply after the decision with USD/CAD at fresh 10-month lows near 1.2650.
The Australian dollar also gained strong support with AUD/USD at 14-month highs above 0.7800.
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