FX Strategy Weekly by Lloyds TSB

=> USD: FOMC likely to trigger initial further USD weakness

=> GBPUSD has scope above 1.60 unless PMIs disappoint Market Outlook

=> USD: FOMC likely to trigger initial further USD weakness

=> GBPUSD has scope above 1.60 unless PMIs disappoint

There is potential for this to be a momentous week in the markets, with the FOMC decision on Wednesday the primary focus, but plenty of other potentially market significant events through the week. At the FOMC meeting the funds rate target will be left unchanged, but the Fed is expected to outline another tranche of quantitative easing in an attempt to provide an extra monetary boost to the economy. It is already fairly clear that there will be some extra easing announced, but the precise form remains uncertain. Speculation ranges from asset buying from $300bn upwards, but it isn’t clear that the Fed will announce a fixed final amount, and there is also potential for other announcements, possibly of an inflation target. The FX market reaction is likely to key off the bond market, and the Fed will probably try to make sure it slightly exceeds market expectations in its announcement and triggers an initial decline in long term bond yields. This in turn should trigger an initial decline in the USD, but the initial move may prove short lived.

Sterling had a very strong week last week, helped by the much stronger than expected 0.8% rise in UK Q3 GDP, and this, combined with some noncommittal comments from BoE deputy governor Bean, makes any UK extension of QE at this week’s MPC meeting look unlikely. We still think the longer term picture for sterling looks fragile, as most of the forward looking data is weak, and the fiscal tightening will start to bite next year. But in the short term the UK PMI data next week may well determine sterling’s tone. A small bounce in the services PMI last month still left it at low levels, and the longer term risks seem to be to the downside, but the latest European data has been reasonably robust, so the outcome is far from certain. The rise in UK yields last week suggests there is scope for GBP/USD to advance through 1.60 if current spreads with the USD are maintained through next week.

As well as the FOMC and the UK MPC and PMIs, we have an RBA and ECB meeting next week, and the US employment report on Friday, plus US midterm elections on Tuesday. We don’t expect the RBA to raise rates after weaker than expected CPI this week, and this may keep the AUD subdued. The ECB meeting seems unlikely to produce much, but should see Trichet effectively confirm that the ECB have been passively guiding short term rates up, which may be favourable for the EUR, though EUR enthusiasm remains restricted by concerns about periphery debt. The latest claims data suggests payroll numbers on Friday could show some improvement, which may be positive for riskier currencies at the end of the week.

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