Sterling Outperforms On Back Of Strong British GDP Numbers


The US dollar initially extended yesterday’s recovery, but reverse lower in Europe, despite elevated tensions in the periphery of Europe. Optimistic comments by ECB’s Stark, seeming to signal another step on the exit strategy, German industry association seeing no threat in the current euro level may have helped fuel the euro’s recovery from the test on $1.3380 support. The dollar-yen remains sidelined—confined to a 30 tick range, slipping to a new post intervention low in front of 84. Sterling is the best performing of the majors, with the apparent help of month end flows, positive M&A talk and although Q2 GDP was confirmed at 1.2%, business investment was stronger and the current account deficit somewhat smaller than expected (though revisions were poor) and CBI Distributive Trades report was well above expectations (49 vs consensus 25 and 35 in Aug). Sterling price action is impressive, as it fell through yesterday’s lows and now has traded above yesterday’s highs—to set a new seven week high–. Despite the dollar’s sudden decline in the European morning, look for a consolidative tone in North America today.

Asian stocks slipped back on worries about growth amid speculation that European government finances are worsening. The MSCI Asia Pacific index fell 0.4%, while Japan’s Nikkei dropped 1.1% led by a fall in health care and energy stocks. In particular, Japanese stocks fell as most companies in the Topix went ex-dividend today. This means that investors who purchased these stocks will not be entitled to receive dividends. In Europe stocks pared their decline as tech shares advanced. In mid afternoon trading the STXE 600 was up 0.21%, while UK stocks slide for a second day as the decline in base metals weighed on mining companies shares.

Ireland led a surge in the cost of insurance against bond default (CDS) amid concern that the cost of bailing out the national banking system is growing. For instance, the Irish 10-year yield shot up nearly 50bps, followed by Portuguese yield with an increase of 27 bps and Greece with an 18bps bump. Japanese bonds continue to climb on speculation about further easing measures from the central bank next week, while demand at a two-year auction increased earlier today. The 10-year note yield dropped 5 basis points to 0.95%. Treasuries were little changed, with the 2-year yield at 0.436% after the strong auction yesterday. The Treasury sells $35 billion of new 5-year debt today.

Currency Markets

ECB’s Stark comments are more important today that increased speculation of a downgrade in Ireland and Spain. In an unusually revealing comment, the ECB’s Stark indicated that a number of the unconventional liquidity measures that are due to expire at the end of the year will in fact do so. This is unusual because it because such policy announcements are more commonly made by ECB President Trichet. It is also unusual in the sense too that it seems to pre-commit to a change in policy. Moreover, Stark’s comment seems to be largely based on one month’s numbers—August money supply and private lending figures.

Stark’s announcement comes on the heels of press reports suggesting that the long-term assets purchases that the consensus expects the Fed to announce as early as Nov may be smaller than the $500 bln-$1 trillion dollar program that many have envisioned. Some cited this as a factor behind the dollar recovery yesterday and today. However, a more incremental approach was anticipated to maximize the Fed’s flexibility so a “QEII-light” is not really new news. With interest rates in the US already very low and mortgage rates very low, and with around $1 trillion in excess reserves, there has always been a question of the effectiveness of a QEII. A light version adds fodder to those arguments. Remember too that in recycling its mortgage proceeds, the Fed’s balance sheet may remain the same size, but may still support Treasury prices as they are projected to buy around $400 bln by the end of next year. Meanwhile, Japan is taking the lead in the next round of government assistance. As noted yesterday, a supplemental budget is in the works and there is increasing speculation that the BOJ will take additional steps at its Oct 4-5 policy meeting. Most speculation has focused on increasing the fixed rate loan period to 6 months from 3 and increasing the rinban operations (JGB purchases).

There are heightened fears of rate action in Spain and Ireland today. Spanish bonds matching German bunds today, but a local paper is warning that Moody’s may cut Spain’s rating after tomorrow’s general strike. This is not as ominous as it may sound. For some inexplicable reason, Moody’s still has Spain rated AAA and we have expected them to cut it. Ireland is more problematic. Moody’s cut Anglo-Irish Bank’s unguaranteed senior debt three notches yesterday. The Irish government is desperate to find closure here and tomorrow it is expected to unveil it latest estimate on the cost of supporting Anglo-Irish Bank. S&P says that cost may be in excess of 35 bln euros (~20% of GDP). The government’s most recent estimate is 22 bln euros. Splitting the difference would be around 29 bln euros, which is about what the Irish government has spent already on the banks. Also tomorrow, the Irish parliament needs to extend the Eligible Liabilities Guarantee program that is subject to review every six months and is currently set to expire at the end of the year. Meanwhile there are reports that the government is squeezing current Anglo-Irish bond holders. The government appears to be seeking to buy back senior debt at a discount or offering to swap for equity in the new asset recovery bank being created out of parts of Anglo-Irish. There are also reports that it is offering the holders of subordinated debt holders (~2.4 bln euros) deep haircuts of as much as 90%.

UK headline GDP growth in Q2 was unrevised at 1.2% q/q, in line with consensus. Growth was supported by household consumption and stock building as the contribution from inventory restocking began to ebb. In addition, real household disposable income is estimated to have dropped, leading to a decline in the saving ratio. Moreover, the largest share of increase came from government spending which is estimated to have risen by 1% q/q. The initial price reaction was sterling positive as the pound rallied by as much as 0.2% against the dollar after the report. In fact, the pound has strengthened the most against the dollar in early trading. At the moment the austerity measures seem to be sterling positive but according to the report one of the largest contributors to growth were government expenditures.

Upcoming Economic Releases

This morning at 9:00 EST / 13:00 GMT the Case-Shiller Housing Index is reported. The m/m data reported for July are expected to fall by 0.1% from 0.28% in the previous month. The y/y data are expected to be positive but fall to 3.1% from 4.23%. In addition, the Consumer Confidence and Richmond Fed Index are both expected to decline from moderate increases the previous month.

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