Evidence of Tensions in The Banking Sector

EUR/USD

The Euro initially dipped sharply to lows below 1.4350 against the dollar on Wednesday with the currency undermined by sharp losses against the Swiss franc as there was no move to introduce a franc peg. The Euro regained ground strongly and pushed to a high just above 1.45 as the dollar weakened before weakening again during the US session with consolidation near 1.44.

The headline Euro-zone inflation rate was confirmed at 2.5%, but there was a significantly weaker than expected reading for the core rate which fell to 1.2%. Diminishing inflation and weaker growth will maintain pressure for the ECB to switch to an easier monetary policy.

Signs of lower inflation will also tend to have some impact in lowering bond yields and the ECB was continuing to discourage short selling in peripheral bonds by its presence either as a buyer or potential buyer. Underlying confidence in the Euro-zone  remained fragile, especially with no agreement on the issuance of Eurobonds.

There was also evidence of tensions in the banking sector as a bank tapped the ECB 7-day emergency liquidity facility for the first time since February. Any further evidence of distress borrowing would tend to undermine the Euro, although the impact should be alleviated by central bank dollar liquidity provisions.

The US producer prices data was slightly stronger than expected with a headline 0.2% core increase while underlying prices rose 0.4%. There was further criticism of the Federal Reserve's policies from regional Presidents Plosser and Fisher who stated that it was not the Fed's role to protect stock-market investors.  If the consumer inflation release is also higher than expected, it will be more difficult for the Fed to justify any further move to expand quantitative easing. 

Yen

The dollar was again trapped below 77 against the yen on Wednesday and dipped to test support below 76.50 before finding some degree of buying interest. There was still underlying yen support from a decline in regional equity markets.

The latest trade data was slightly weaker than expected as exports recorded a drop of 3.3%, the fifth successive annual decline with a particularly sharp drop in shipments to the US.

The Finance Ministry continued to warn that it was watching markets closely. The batch of US data will be watched closely on Thursday and a higher than expected reading for inflation could provide some support for the dollar.

Sterling

The latest employment data was weaker than expected as the unemployment claimant count rose 37,100 for July, the largest increase for two years after a revised 31,300 increase the previous month as the unemployment rate rose to 7.9% from 7.7%.

The Bank of England minutes recorded a 9-0 vote for unchanged interest rates at the August meeting as Weale and Dale dropped their preference for higher interest rates and this was the first unanimous vote on interest rates since May 2010. There were further concerns over the economy, but the majority of members did not consider that it was appropriate to expand quantitative easing at this time.

Sterling initially fell sharply following the minutes and employment release, but then rose sharply with an important element of short covering. Sterling rose to a 14-week high above 1.6570 against the dollar before a partial retreat and also rose to near 0.87 against the Euro. Real yields remained highly negative as the 10-year benchmark gilt yield fell to below 2.45%.

Swiss franc

The Euro briefly pushed above 1.15 against the franc on Wednesday and the dollar also tested resistance above 0.80 on further speculation that the Swiss authorities could move to a currency peg.

The National Bank announced that it would increase sight deposits further to CHF200bn from CHF120bn and would also consider intervention in the swaps market in order to push interest rates deeper into negative territory.

The decision not to move to a peg triggered a sharp market reversal as the franc advanced strongly. There was further franc volatility during the day with the announcement of a government press conference where further support for industry was announced, but again no move to peg the Euro.  The dollar found support below the 0.7850 level.

Australian dollar

The Australian dollar maintained a strong tone during Wednesday and pushed to a high near 1.06 against the US dollar before retreating later in the US session. There were further losses in Asia on Thursday as it retreated back to below 1.05.

The currency was undermined by a further decline in Asian equity markets as fears over the global growth environment persisted. There was also a decline in key commodity prices on expectations of weaker demand which had a negative impact. There were no domestic economic data releases with markets still expecting a less hawkish tone from the Reserve Bank.