The Euro made strong gains on Thursday afternoon and on Friday as the president of the European Central Bank, Jean Claude Trichet made some hawkish comments about future interest rate direction. After confirming the European interest rate would remain at 1% for January, Trichet said that rising commodity prices could risk pushing Eurozone consumer price inflation further above their 2% target. He went on to say that if inflation became entrenched the ECB would take action. This is essentially an admittance that the ECB would consider increasing interest rates if inflation continues to increase.
As exchange rates are fundamentally driven by interest rates and expectations of future interest rates, any hint that rates may rise causes a currency to jump up. Especially as interest rates are low at 1%, any hint one way or the other can have a pronounced impact.
These comment combined with successful bond auctions in Portugal and Spain, pushed the Euro to a strong position against the Pound and the US Dollar. Demand for Spanish bonds was especially strong with investors bidding for 2.1 times the securities on offer.
Back in the UK, The Bank of England kept interest rates unchanged at 0.5% and kept their bond purchasing level at £200 billion. We will have to wait until the minutes of the meeting in two weeks to gauge whether any policy makers joined Andrew Sentence in recommending a rate increase. However as inflation is more entrenched in the UK than it is in Europe or America there is some speculation that some Monetary Policy Committee may have a more hawkish stance than during last month.
The week ahead as always is expected to be interesting, especially for the US Dollar. Leading manufacturing and business confidence indicators like the Empire State and Philly Fed indices are released. There are is also unemployment data released on Thursday. The last set of unemployment data was unexpectedly positive and indicated that the US economy may be recovering from recession.
In the UK the Consumer Price Index is released on Tuesday. Headline inflation has been above the Bank of England target of 2% for over a year now and is expected to remain around the 3.3% level in December. This could push Sterling higher as the Bank of England Monetary Policy Committee would be pressured into increasing interest rates a lot sooner than was previously expected.
This week will also be notable for anyone with an interest in Polish Zloty or the Canadian Dollar as their Central Bank s are meeting and announcing interest rates.
