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Daily News from Senior FX Analyst – Samuel Allen

Risk aversion continues to dominate the markets and the usual flux of money into fixed income bonds has continued with bond prices coming up sharply this month both in America, Europe and the UK. Inflation data this morning showed that UK inflation eased to 3.1% in July from 3.2% in June, the third month in a row that prices have risen more slowly but still above the target figure of 3%.

Mervyn King has cited the devaluing of sterling as one of the main factors contributing to this higher inflation. He still maintains that the rise is only temporary and that inflation will again start to drop towards the end of 2011 which is an indication that interest rates will remain where they are well into 2011. Higher interest rates along with a positive economic outlook would help the pound to gain value against most currencies. This low interest rate and low economic growth picture which has been painted today has helped to drop the pounds value significantly.

GBP/EUR has dropped from its 2 month high yesterday back down to support at 1.21, as long as this support holds the uptrend would still be considered intact, a drop below 1.2 could see further prolonged weakness. The pound has also dropped significantly away from resistance at 1.6 which was a 6 month high against the Dollar. Risk aversion is dominating the Dollar market and as more and more clues towards the double dip become evident, we might well see that rate drop further.

The German ZEW institute’s measure of investor and analyst sentiment dropped well below forecasts, though this was partly offset by an unexpectedly sharp jump in the current conditions index. This figure will reflect badly on growth forecasts for Germany and without their growth helping the Euro-zone things could become very precarious.

A sign that things might not be as bad as predicted were the solid results of Irish and Spanish bond auctions. Ireland’s sale of 2014 and 2020 paper was viewed as a litmus test for investor appetite amid concerns about the cost of cleaning up its banking sector. Sales of 12- and 18-month Spanish treasury bills also met strong demand.

The technical picture remains the same with GBP/USD in an uptrend, support is around 1.5500 GBP/USD, below this level the pound could come under pressure. Same applies against the Euro, above 1.200 GBP/EUR support and all is well, below that and we could feel the squeeze. It is certainly worth considering a ‘stop’ order with your broker if you are looking to secure either of these currencies in the near term, the advantage of this is that if the rate continues to get better then you can benefit from the rise but if it does fall off the cliff then your guaranteed a good rate.

Australian elections later this week could result in a hung parliament which might well weaken the rate back to 1.8 GBP/AUD resistance or beyond. The Australian Dollar is also susceptible to any return to risk aversion or a general slowing of global consumption of their vast natural resources.