Mervyn King, the Bank of England Governor, all but signed off on a rate cut for

February next year. This caused a sell-off in sterling, most noticeably in the GBPUSD

pair which looked over-priced at the 2.10 highs. The main risks for sterling and the

UK economy lie in the fact that inflation continues to rise, but at the same time we are

entering a period of economic downturn. The outlook for growth presented by the

Inflation report was noticeably pessimistic and acknowledged that the recent US

slowdown and global credit crunch would have a dampening effect on UK activity.

However, the report also acknowledged that commodity and food driven inflation will

continue to rise. Indeed, Tuesday’s CPI figure confirmed this (see below). The

problem the MPC face is, in the face of rising price pressure, the committee needs a

good excuse to cut rates, especially given that they are committed to controlling

inflation through the interest rate mechanism. So bizarrely, we had the Governor

claiming stock markets were overvalued and traders should sell. The reason for this;

a fall from the relatively high levels would give the Bank sufficient reason to cut, as

this would imply we were heading into a downturn or recessionary period.

The pound fell across the board with GBPEUR reaching a 4 ½ year low at 1.3940

during the London session on Friday.

The Inflation conundrum

Last week’s Consumer Price Index would have been concerning for the Bank of

England. The headline number showed the biggest rise since June and took the

year-on-year figure to 2.1%. The dilemma the MPC face is that while inflation

continues to rise, activity and growth are clearly slowing significantly, and should

continue to do so in the current economic climate. The riddle, in economics, is known

as stagflation, a period of recessionary conditions with simultaneously high price

pressure.

This environment is likely to be negative for sterling as policy makers cannot afford

not to cut rates, they must somehow offset the inevitable slowdown that will result

from the credit tightening crunch. However, recent high fuel, commodity and food

prices do not look like abating.

The week ahead

The main release will be the Bank of England MPC minutes. Prior to last week,

the market was expecting to see an 8-1 split with the majority voting for a cut.

This may change however, but since the Inflation Report (mention above) has

already caused the pricing in of a cut. We therefore do not expect to see

significant moves from the release.

The Fed minutes will be released on Tuesday night. This may offer a little

breathing space for the dollar. The market is pricing in a 90% chance of another

cut before December, and 75% of analysts are expecting the same. However,

interestingly, recent comment from the fed has hinted that they may be content

with the current levels in the short-term. If this is indeed true, we may see the

dollar inch up a little and the higher yield, higher risk currencies come under

some pressure.

Economic Research

0207 801 9084

j.e.henson@worldfirst.com

Currency Rates Low High Current

GBPEUR 1.3942 1.4266 1.3976

Euro continued to gather momentum last week against higher yield G7 currencies,

mainly sterling and US dollar but slipped against the lower yield CHF and JPY. The

German ZEW index fell to a record low of -32.5 on its October reading which

reinforced thoughts that an economic slowdown may be on the cards. GDP was firm

at 2.6% however the 4th quarter could prove to be key as credit crunch concerns and

banking institution difficulties should be taken into consideration.

GBPUSD “Cable” 2.0350 2.0866 2.0492

Fears continue in the US over consumer spending pressure and possibilities of

Federal Reserve rate cuts. Any reduction of carry trades would provide some support

for the greenback, particularly if emerging markets weaken. Falls in commodity prices

towards the end of the week also helped dollar strengthen as defensive moves into

T-Bills and Gilts began. Speculation continues this week over whether OPEC

countries Qatar and the UAE will drop their dollar peg in favour of a tie to a more

stable currency or a completely free float.

Commodity currencies

A slight unwinding of the carry trade has seen commodity currencies come under

pressure in the past week.

Low High Current

GBPAUD 2.2790 2.3514 2.31.64

Carry trade pressures were the main driver behind weakening of the AUD over the

past week. With no really important data released last week, commodity currencies

took their cues from their underlying commodities; gold and copper falling sharply last

week. We see further volatility in line with carry trade unwinding.

GBPNZD 2.6616 2.7772 2.7126

Watchers of Kiwi dollar will be mindful of global equity movements this week as any

and every movement downwards we see on the DJIA or FTSE will surely be

mirrored. With no data being published this week, the carry trade will once again

become the main governor of Kiwi movement.

GBPCAD 1.9639 2.0209 2.0138

As with all commodity currencies, CAD has been brought closer to parity over the

past week due to liquidity fears and carry trade worries. Fears of deterioration in

competitiveness abound as manufacturing shipment figures fell by 0.9%.

Retracements in the price of a barrel of oil and concerns over multinational banking

sectors also hurt the loonie.

GBPZAR 13.475 13.925 13.85

Following a fairly hawkish review of the economy earlier last week another rise in

interest rates seems to be on the cards for December by the MPC. Rand was hurt a

smidge by a fall in manufacturing output due to an earlier 3 week strike although this

is not believed to signal any cooling of inflationary pressures.

GBPCYP

Please see GBPEUR comments above. EURCYP is pegged in preparation for Euro

entry and so GBPCYP moves proportionally with GBPEUR. [Update: The Cypriot

government has allowed the currency to strengthen very slightly to 0.573 against

EUR, in light of market pressure. The pair is now stable here.]

Produced by Jabu Henson and Jeremy Cook (j.e.henson@worldfirst.com) Please feel

free to contact me at anytime regarding these briefings, if you have any questions or thoughts

on them, or if you are interested in a particular event in the calendar.

Please call us on 0800 001 5055 if you have any questions or would like to discuss the

markets.

Please reply with REMOVE in the subject of your e-mail if you would like to be removed from

this list.

Notes:

The above comments are only our views and should not be construed as advice. You should

act using your own information and judgement. Although information has been obtained from

and is based upon multiple sources the author believes to be reliable, we do not guarantee its

accuracy and it may be incomplete or condensed. All opinions and estimates constitute the

authors own judgement as of the date of the briefing and are subject to change without notice.

Any rates given are interbank and therefore for amounts of £5million and so are not indicative

of rates offered by World First for smaller amounts.

This week’s data

Tuesday 20 November Previous Expected

US 19:00 FOMC minutes from 30-31 October

meeting

Germany 07:00 Producer prices, % M/M Oct 0.2 (1.5

Y/Y)

0.3 (1.6

Y/Y)

Swi 07:15 Trade balance. CHF bn (nsa) Oct 1.7 1.5

Norway 09:00 Mainland GDP, % Q/Q Q3 1.3 (5.8

Y/Y)

0.9 (5.1

Y/Y)

UK 09:30 Public sector net cash requirement, £bn Oct 9 -8

UK 09:30 BBA and BSA mortgage lending &

consumer credit

Oct … …

UK 11:00 CBI industrial trends survey – total orders Nov -6 -8

E13 10:00 Construction output, % M/M (sa) Sep 0.4 (2.8

Y/Y wda)

Canada 11:00 Consumer price index, %Y/Y Oct 2.5 2.8

Canada 11:00 Bank of Canada core CPI, %Y/Y Oct 2 2

US 13:30 Housing starts, mn units Oct 1.191 1.17

Japan 23:50 Trade Balance Total, bn yen Oct 613.4 …

Japan 23:50 All Industry Activity Index, % M/M Sep 1 -1.5

Wednesday 21 November Previous Expected

UK 09:30 MPC minutes from 7-8 November

meeting

Nov 8-1 7-2

Canada 13:30 Retail sales, %M/M Sep 0.7 0.1

Canada 13:30 Retail Sales less autos, %M/M Sep 0.3 0.3

US 13:30 Initial jobless claims, thous (4wk mvg avg) 17-Nov 339 (330) 330

US 15:00 Michigan consumer sentiment, index Nov F 75 75

US 15:00 Leading indicators, % M/M Oct 0.3 -0.3

Thursday 22 November Previous Expected

Germany 07:00 Final GDP,% Q/Q Q3 – F 0.7 (2.5

Y/Y) P

0.7 (2.5

Y/Y)

E13 09:00 Current account, ¤ bn (sa) Sep 3.8 3.4

UK 09:30 Business investment Q3 – P 0.4 (7.8

Y/Y)

1.1 (6.1

Y/Y)

E13 10:00 Industrial orders, % M/M Sep 0.5 (6.0

Y/Y)

-0.8 (6.1

Y/Y)

Friday 23 November Previous Expected

Germany 07:00 Import prices, % M/M Oct 0.6 (1.3

Y/Y)

0.4 (2.0

Y/Y)

E13 09:00 “Flash” manufacturing PMI, index Nov 51.5 51.0

E13 09:00 “Flash” manufacturing input prices, index Nov 59.0 …

E13 09:00 “Flash” services PMI, index Nov 55.8 55.2

E13 09:00 “Flash” Composite PMI, index Nov 54.7 54.1

UK 09:30 GDP – second estimate Q3 0.8 (3.3

Y/Y) P

0.8 (3.3

Y/Y)

Norway 09:00 Unemployment rate (AKU), % Sep 2.5 2.4

Definitions

Bull/Bullish: one who thinks a market, currency or asset will appreciate

Bear/Bearish: one who thinks a market, currency or asset will depreciate

Pip: the fifth significant figure of a currency price: 1.2345

Big figure: the third significant figure of a currency price: 1.2345

Basis point: a 0.01% unit

Tightening (Interest Rates): raising interest rates (loosening is opposite)

Hawkish: comments that suggest interest rate tightening i.e. moving higher

Dovish: comments that suggest interest rate loosening i.e. moving lower

MPC: Monetary Policy Committee, the body that sets UK interest rates

ECB: European Central Bank, the body that sets the Eurozone interest rate

RBA: Reserve Bank of Australia: the central bank of Australia.

Cross-Currency Pair Flow: Where a set of three interlinked rates, e.g. GBPEUR, EURUSD and

GBPUSD, move as any combination of two of these rates must produce the third in order to satisfy a

condition known as No Arbitrage. If there are movements in two markets, then the third must move

deterministically. Also knows as triangulation.

Carry Trade: Simply put, is the borrowing of money in a low interest economy (Japan) and investing it in

a higher yield economy (Australia). This yields a certain profit unless the interest rate differential

narrows, or the exchange rate moves such that it costs more to buy the currency back.

Fair Value- Also called financial fair value: A measure of the theoretical exchange rate using certain

Macroeconomic models (such as eCIP).

Underlying Inflation: A somewhat academic measure of long-term inflation- removing all the’

interesting’ elements like energy and luxury consumption leaving the ‘boring’ elements like utility bills

and food. [Quotes from BoE governor Mervyn King]

Interest Rate Traction: Although there is a group of people who announce an interest rate, it has to feed

through the economy through some very complex and poorly understood channels. Once rate hikes are

having an effect on inflation and long term yields it is said that they are finding traction with the

economy.

Unemployment rate: The percentage of people who are able and ‘willing’ to work (ie in the labour

force) who are not employed.

Participation rate: The percentage of the population of working age in the labour force