Sterling Spanked

Following soft consumer confidence and employment data, the Bank of Enlgand's inflation report failed to satisfy the sterling bulls, who have had the upper hand in the foreign exchange market, and the rate hawks, who have had their way in the debt market. The BOE maintained its view that CPI will be below target in 2-years time at 1.7% compared with 1.6% in the November report. BOE expects further upside pressure on CPI in the coming months.

Although at first read, the report and King's comments have something for everyone, on balance, the BOE still sees the price pressures as largely temporary. King specifically noted that he was not endorsing the market's outlook for rates, which as we have noted previously, was consistent with a hike in the next three quarters. The take away message is that the BOE is not in a hurry to hike rates, with King suggesting that the economic shocks and excess capacity means the BOE can take longer to meet the CPI target.

Today's UK earnings data, that for December showed a further drop in wage growth. with average earnings growth slowing to 18% at an annualized rate in the last three months of 2010 compared with 2.1% in the three-month annualized pace through December, and underscores the lack of cost-push inflation. Sterling fell more than a cent in response, which given market positioning, was vulnerable to a "buy the rumor, sell the fact" type of activity in any event. The debt market rallied across the board and helped trigger a broader market response.

The market appeared to have misunderstood developments in Switzerland today. The real signal was from the Hildebrand, the head of the central bank. He appeared to see virtues in the Swiss franc's strength, citing its ability to restrain inflation as the economy recovers. He also warned that rates could not be maintained as such low levels. The 3-month LIBOR target was cut to 0.25% in March 2009 and remains there now. The SNB meets again on March 17. A rate hike is not likely then, but a Q3 moves still seems reasonable. However, the gains in the Swiss franc were reversed when headlines hit indicated that the Swiss government was to announce measures to curb the Swiss franc.

What was announced were measures to help industry cope with the strong franc, like funding for tourism,, liberalized export insurance program, R&D promotion. The government's measures are not really franc=negative though the market took the euro from about CHF1.3030 to CHF1.3130. That the knee-jerk reaction may have been exaggerated is further driven home by the government's conclusion that it is ultimately up to companies themselves to deal with the vagaries of the foreign exchange market.

Ahead of the Irish elections next week and the ongoing stains in the euro zone, volatility in the foreign exchange market may increase and the Swiss franc may be a key beneficiary. Today's pullback may offer better entry levels for those who share this concern.

Although not a big market mover, developments in Denmark are noteworthy as investors contemplate solutions for the euro zone debt crisis. The Danish government has let senior bond holders take losses in the failure of Amagerbanken on Feb 6. Moody's responded today by cutting the ratings for five large Danish banks. Financials are lower in Denmark, but not down as much as the broader market. The impact seems minor.

Fast forward to the Irish elections next week. The latest polls show the Fine Gael's lead in the polls is increasing. It is not impossible for it to secure an outright majority, though this might not be the odds on most likely scenario. Leaders from that party seem more willing to reconsider the decision by the current government to treat senior bond holders like depositors. The EU continues to insist that Ireland adheres to this policy ostensibly because of contagion risks.