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Main News Daily Update

Confidence in the British pound is a fragile thing. Support needs to be found through fiscal stability, interest rate potential and economic expansion to support expectations that the sterling is on strong enough to catch up to its largest counterparts. Today, the single currency was provided a particularly strong boost from an oftentimes overlooked indicator. The CBI’s distributive trends report (a proprietary reading of retail activity) far outstripped expectations with a net 33 percent of respondents reporting a boost in sales – the highest reading since April 2007. Today marks the first of four key BoE events that take place over the next four weeks that could decide the direction of sterling and gilts over the remainder of Q3. The testimony to the TSC has not been kind to GBP over the last three sessions. Admittedly the last three testimonies took place in a different economic and political context compared to today and therefore need not necessarily be a guide to what to expect today. If we trace the rally in sterling and firmer yields to the relief bounce in risk post EU stress tests and ‘generous’ new Basel leverage rules, then one wonders if today’s TSC testimony will disrupt momentum. What is clear is that investors have ignored the more dovish rhetoric from the July minutes and individual MPC members, instead playing up to the weaker USD and bullish price action in stocks. The risk is that governor King reins in optimism and warns of the numerous pitfalls ahead. The TSC hearing features governor King and lone hawk Sentance among others; we are interested to hear from the governor what he makes of the strong Q2 GDP numbers last week and how confident he is of predicting the outlook for a more mediocre second half.

The preliminary German CPI is expected to have risen by a modest 0.1% in July to be 1.0% higher than a year ago. This follows annual inflation moderating to 0.8% in June. At July’s ECB press conference, Jean-Claude Trichet noted that some pick-up in price pressures were likely in the short-term. Although the money supply expanded for the first time in eight months in June, that outcome did not take into account July’s expiry of the ECB’s 12-month repo – a lending facility allowing European banks to secure access to the central bank’s funds for a year – which amounted to large liquidity drain and put upward pressure on short-term borrowing costs. Indeed, European 2-year yields overtook those of the US for the first time in three months at the beginning of this month and now trade at a 25bps premium, meaning Euro Zone monetary conditions are at their most restrictive since mid-February. With borrowing costs set to push higher still as governments issue debt to finance their gaping deficits and economic growth likely to slow amid a lurch toward austerity, the path of least resistance for the ECB points toward (at least) a static posture, with the possibility of greater easing seemingly far greater than that of tightening.

After declining in May, US durable goods orders are expected to have rebounded, up 0.5% on the month in June. Conversely, we are looking for a moderation in durables excluding the volatile transportation component, as underlying demand remains muted. However, as demonstrated by the stronger than expected US home sales earlier in the week, Lloyds TSB do not believe there will be any significant reaction to the result as investors await the advance estimate of Q2 GDP on Friday. The release of the Fed’s Beige book is not expected to provide any ‘new’ information with the commentary reiterating the dovish tone of the June FOMC minutes and Fed Chairman Bernanke’s testimony last week.

Data on South African inflation in June is also due to be released today. This number could get some attention following last week’s decision by the South African central bank to leave rates unchanged. Risk appetite seems to be returning and that has helped EMEA markets since the start of the week. Most notable in our view is the continued strengthening of the South African rand – against all odds.