USD Looks Higher Ahead Of Key Events, GBP To Benefit From BoE Policy

The Dow Jones-FXCM U.S. Dollar Index (Ticker: USDollar) is relative flat on the day after moving 100 percent of its average true range, and the greenback may continue to retrace the decline from 10,046 as the 30-minute relative strength index bounces back from a low of 33. In turn, we may see the ascending channel continue to take shape ahead of the highly anticipated Non-Farm Payrolls report, and market sentiment may weaken further over the near-term as the sovereign debt crisis continues to dampen the outlook for Europe. However, the European Central Bank interest rate decision on tap for Thursday may encourage risk-taking behavior as President Mario Draghi is expected to announce an unlimited bond-purchasing program, and we may see the Governing Council take additional steps to stem the risk for contagion as European policy makers struggle to restore investor confidence.

As the ECB steps up its effort to address the debt crisis, the move may encourage the Fed to preserve its wait-and-see approach in September, and the FOMC may strike a more neutral tone for monetary policy should the employment report top market expectations for a second month. Although NFPs are projected to increase only 127K in August, an upside surprise paired with a pickup in wage growth should sap speculation for another large-scale asset purchase program, and the Fed may sound more upbeat towards the economy as private sector activity gradually gathers pace. As there remains no immediate threat for a double-dip recession, the FOMC is certainly well positioned to maintain its current policy, and we may see the USDOLLAR breakout of the downward trend from June should Chairman Ben Bernanke talk down speculation for QE3.

Three of the four components strengthened against the greenback, led by a 0.22 percent rally in the British Pound, and the sterling may continue to appreciate against its U.S. counterpart as the Bank of England is anticipated to keep the benchmark interest rate at 0.50 percent while maintaining its asset purchase program at GBP 375B. As the Funding for Lending program is expected to boost economic activity, we may see the BoE slowly move away from its easing cycle, and Governor Mervyn King may continue to endorse a wait-and-see approach throughout the remainder of the year as growth and inflation picks up. As price growth in the U.K. tracks higher, we may see the central bank scale back its forecast for undershooting the 2 percent target for inflation, and the Monetary Policy Committee may start to soften its dovish tone for monetary policy as the region appears to be emerging from the double-dip recession.

--- Written by David Song, Currency Analyst

To contact David, e-mail dsong@dailyfx.com. Follow me on Twitter at @DavidJSong.

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