The Pound is Sterling, Aussie's Shine Tarnished

The value-added tax is set to rise in a handful of European countries this year, with the UK's 2.5 percentage point rise (to 20%) is the largest followed by Portugal's 2 percentage point hike (to 23%). Slovakia , Poland and Latvia have 1 point hikes (20%, 23% and 22% respectively). The UK's Telegraph reports that retailers may raise prices 5-8%. Consumers apparently tried to get in ahead of the VAT hike and high frequency retail sales reports, like John Lewis, showed a large rise.

While these purchases likely borrow from early 2011 purchases, the pricing pattern warns of upside risks to CPI. Meanwhile, CIPS manufacturing survey (~PMI) rose to 58.3, the highest level since late 1994. Input prices, as was seen in yesterday's US report as well, jumped in the UK to 81.2 from 72 and is the highest in the UK since the time series began almost two decades ago.

The UK also reported stronger than expect building approvals. Money supply (M4) growth was softer than expected, but the BOE prefers to look at the money supply excluding financial transactions not seen as economically significant and by this measure (M4 excluding other financial corporations) rose at a 3-month annualized rate of 3.5% (compared to a 2.7% pace in Oct) and is the highest since March. While sterling had turned better bid in the Asian session, the data helped extend its gains. The next immediate target is the high from New Year's eve near $1.5665, with a retracement objective coming in near $1.57.

Australia has been everyone's darling, but the economic news stream appears to be deteriorating. Two items today are noteworthy and they come in the context of the moderation of the Chinese manufacturing sector as illustrated by the recent pullback in its PMI. We have been highlighting the weakness of the Australia's domestic economy and that point is underscored by today's PMI. Australia's manufacturing PMI fell to 46.3 from 47.9, which is the fourth consecutive month of sub-50 reading. The details also looked soft with employment felling 1.8 points to 44.1 and output falling 2.4 points to 46.6.

On top of this, rains and floods in the Australian state of Queensland is disrupting supplies of steel and coal, which are primarily for exports. The Australian dollar rallied about 7.5% against the US dollar in December and is vulnerable to profit taking. A break of $1.0050 could spur another cent near-term pullback.

A report that might have been lost on many at the end of last week may be a preliminary indication of a shifting investment flows. What caught our eye was the report by the Investment Company Institute that showed the first weekly inflow into US equity funds in 8 months (for the week ending Dec 21). By their figures some $90 bln was pulled out of US equity funds in from May through mid-December.

The streak of inflows seen by bond bunds since mid-Dec 08 appears to have also been snapped. ICI reported that bond funds experienced the third consecutive week of outflows. It is not quite a shift from bonds to equities though, as ICI reported about $335 mln went into US equity funds but $4.4 bln left bond funds. The difference may have helped inflate the flow going into money markets. ICI reports that in the week ending Dec 29, money market took in $22.4 bln largely recouping the outflow of the previous two weeks.

It is too early to draw hard conclusions from the year end portfolio adjustments, but we will continue to track such data. Our favorable outlook for the dollar was partly augmented by our expectation that growth differentials, the uncertainty stemming from the European debt crisis, the relatively healthy relative performance of US stocks last year may encourage Americans to keep more of their money at home in the coming months.