FX Strategy Weekly by Lloyds TSB

=> Pro-risk currencies unfazed by EU periphery troubles; focus on G20

=> BoE QIR to test sterling resilience • Market Outlook

=> Pro-risk currencies unfazed by EU periphery troubles; focus on G20

=> BoE QIR to test sterling resilience

A quiet data and event calendar means the dust should settle somewhat over global asset markets over the coming week, allowing investors to catch their breath and consider what will influence financial markets over the closing weeks of 2010. Risk appetite received a shot in the arm from the $600bln Fed Treasury purchase programme and this largely managed to neutralise escalating fears over the euro zone periphery where bond and CDS spreads hit new record highs. Though long high yield and commodity currency positions already look stretched technically, attractive yield differentials and QE flows from US into non-US assets are likely to spur additional EM and commodity flows. A rally in S&P and CRB through medium-term resistance levels at 1,220 and 300, respectively, means that AUD and NZD could be the recipients of additional speculative flows vs the USD even as fair value levels are breached. Though correlations with risk have only featured occasionally as a driver for G10 FX, they could become more prominent in an environment where even upbeat US macro data and higher short-term Treasury yields are ignored.

The MPC decision to stand pat on Bank rate and keep the APF unchanged at £200bln provided sterling with its own tonic, helping EUR/GBP to slip back below 0.87 and GBP/USD to extend over 1.62. With underlying price pressures not easing and incoming activity data holding up in early Q4, downside risks for sterling appear limited in the short-term. Comments by BoE governor King on the UK economy have in the past not been taken kindly with regard to sterling, but dangers of a dramatic pullback during the presentation of next Wednesday’s Inflation Report should in our view not be exaggerated. Above previously forecast 2010 GDP growth and modestly higher CPI inflation for Q3 vs the August projection should not dissuade the MPC from forecasting below target inflation in two years time. Against a background of fiscal tightening, this implies that additional QE will not be ruled out if the economy loses momentum.

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