Yen and Sterling Drive the Dollar

The US dollar is firm against most of the major currencies, with the main exception being the Japanese yen, where the greenback has extended its recent losses to trade below JPY97.00 for the first time since late June. The US dollar had already fallen more than 2% from the pre-weekend high near JPY100, but sharp equity losses saw the dollar's losses extended. 

The Nikkei fell 4%, the most in 2-months. Poor earnings and guidance weighed on share prices and there was heightened concern about the Fuskushima continuing to leak contaminated water. The BOJ two-day meeting ends tomorrow and although the BOJ is not expected to take fresh actions, it is likely to provide some forward guidance of its own and indicate that it is prepared to do if necessary to achieve its objectives.

It is the Bank of England's forward guidance today that shook trading in the London morning. The BOE effectively signaled rates will be low for longer. It linked its interest rate policy to the ILO unemployment rate. It said it will review its stance when the unemployment rate reaches 7%, suggesting, like the Fed, a threshold rather than a trigger. And it says that it does not see this threshold being hit until at least Q3 2016. It is also, of course, conditioned by financial stability and the medium term inflation outlook. The BOE left the door open to resuming gilt purchases, if needed.

Given expectations and the recent data, Bank of England Governor Carney had to thread a needle. He had to be both dovish and optimistic. The BOE's inflation forecast was trimmed, with CPI expect4d to peak in Q4 13 near 2.9% rather than 3.1% forecast in May and is expected to fall below 2% by Q3 2015. It forecasts 0.6% growth this year and 2.6% over the next 2-years, up from 2.2% in May.

Short-term interest rates fell, with the short-sterling futures curve implying 4-6 bp lower yields. Longer-term interest rates rose, with the 10-year gilt yield racing 10 bp higher in the initial reaction. Sterling fell about a cent to test $1.52, but quickly recovered fully. The euro spiked to GBP0.8730 from GBP0.8680, but also quickly returned to status quo ante.

Sterling had under-performed in recent days and much of the quarterly inflation report was not surprising, including the 7% unemployment threshold. The time frame of its forward guidance is longer than expected and therein lies the surprise, though it should be mitigated by idea that there is a trade-off between length of forward guidance and credibility.

On balance, we still suspect the US dollar is vulnerable near-term and look for the euro and sterling to trade higher. The dollar, tested a retracement objective against the yen near JPY96.75. The next level of support is seen near JPY96, but a return to the mid-June lows near JPY94.00 cannot be ruled out. On the upside, a move above JPY97.50 would help stabilize the tone, but the JPY98.00 area may offer stronger resistance.