Comparatively stronger UK economic conditions have given the British pound a leadership role, and while the Eurozone and US continue to lag, selective GBPUSD and EURGBP trades look especially promising.
The British pound (GBP) ended Thursday unchanged against the US dollar (USD) and euro (EUR). No UK economic reports were released, and while we heard from a number of Bank of England (BoE) policymakers, including Governor Mark Carney and monetary policy committee (MPC) members David Miles, Paul Fisher, and Ian McCafferty, their speeches were similar and the comments posed no threat to the currency.
All acknowledged the recent improvements in the UK economy, with some saying that it has gained momentum. They also expressed hesitations, which ranged from the recovery being very new to the fact that there are elevated risks still facing the economy.
While we are can argue that the central bank, on balance, has grown more optimistic, Carney also made it very clear that the BoE would not change the level of quantitative easing (QE) until the unemployment rate falls to 7%, which is a position that has been clearly stated in the past.
What is interesting is that while Carney said additional stimulus is possible if the economy needs it, he also added later on that the BoE would have "no problem with raising rates if needed."
Current BoE forecasts call for the 7% unemployment level to be reached in 2016, but the market is pricing in tightening in January 2015. To this point, Carney said investors and economists simply disagree.
While monetary policy is expected to remain unchanged for the foreseeable future, if next week's UK economic reports continue to surprise to the upside, we would not be surprised to see GBPUSD trade at the lofty 1.60 level.
A Much Different Story for the Euro
As noted, the euro ended Thursday unchanged against the dollar and pound, which was actually impressive after Eurozone industrial production dropped five times more than expected in the month of July, raising fresh concerns about the region's underperformance.
While the drop was not unexpected given the decline in German and French output, the magnitude of the deterioration was surprising. We believe that the outlook can worsen, too, putting additional pressure on the shared currency and potentially driving EURUSD below 1.31.
As we saw today, however, EURUSD may not be the biggest victim of euro weakness. Instead, steeper losses could be seen in euro crosses like EURGBP and EURNZD.
European Central Bank (ECB) President Mario Draghi expressed the same amount of skepticism as we heard at the beginning of the month after the ECB meeting. Draghi said the Eurozone recovery is still "very, very green," and he doesn't share the market's enthusiasm about a potential return to form.
Draghi also feels that the rise in money market rates is unwarranted, but believes that forward guidance has been successful in ushering rates lower and decreasing volatility.
In the monthly bulletin, the ECB reiterated its pledge to keep rates low for an extended period of time. While confidence indicators confirm gradual recovery, policymakers "remain particularly attentive to the implications" of a "gradual reduction in excess liquidity."
Meanwhile, the Italian Senate has postponed its vote on the embattled Silvio Berlusconi until next Wednesday, September 18.
By Kathy Lien of BK Asset Management