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Euro Weekly Update - July 29th 2016

Euro Weekly Update - July 22nd 2016After its hour in the sun during last Thursday's European Central Bank press conference the euro rather faded into the background.  Friday's provisional purchasing managers' index readings from Germany and pan-Euroland were mostly better than forecast and IFO's survey of German companies found them more upbeat than expected.  The same went for the EC's own confidence measures, which were all unchanged or better on the month.  None made much difference to the currency.

When Markit, a financial information firm, publishes its monthly provisional purchasing managers' index readings for Europe and the United States it does not usually include the UK figures. On Friday, for the first time, it did so. The preliminary manufacturing sector PMI for July came in at 49.1 and for the services sector it was 47.4. Both were sharply lower and both were below the 50 breakeven level at 49.1 and 47.1 respectively. Whilst the PMIs on their own are not sufficient to identify a recession, they are early indicators of how the private sector is performing. And sub-50 readings mean it is slowing down.

The reaction of investors was unequivocal. They did not like what they saw and they took it out on the pound, instantly knocking one US cent and one and a half euro cents off sterling's value.

Having been hawkish for most of his tenure at the Bank of England, MPC policy maker Martin Weale rocked sterling's boat by telling the Financial Times that Friday's weak PMI readings had persuaded him that further monetary stimulus is necessary. His change of mind makes it more likely that the MPC will cut interest rates next month, which caused the pound to fall to a 12-day low against the euro.

It’s easy to forget a time before the EU referendum; such has been the tumult in the wake of the shock Brexit vote in June. On Wednesday we were reminded of this more sedate period, following the release of the Q2 GDP figures, which revealed that the UK economy had a stronger-than-expected performance in the run-up to polling day. Growth accelerated to 0.6 percent during the second quarter of 2016, official figures show. It follows growth of 0.4% in the first quarter, the Office for National Statistics said. Unsurprisingly, this expansion is likely to mark the end of more than three years of uninterrupted growth. Recent surveys show that business and consumer sentiment have been dented by the Brexit vote last month. Consequently, economists predict GDP will fall in Q3 and Q4, forcing Britain into its first recession since 2009.

Investors saw no reason to buy sterling on the back of the GDP data and the CBI Distributive Trades Survey, published 90 minutes later, contained nothing to change their minds. At -14 it represented the biggest monthly fall in over four years. It was unchanged against the euro as a result.

The US Federal Reserve issued its latest monetary policy statement which, as expected, revealed that the target range for the federal funds rate will remain between 0.25%-0.5%; maintaining the ultra-low level they have been at since December 2015. The Fed said "near-term risks to the economic outlook have diminished," but inflation remained below the bank's target. In doing so they paved the way for raising interest rates later this year but stopped short of signalling that move could come as soon as September. Whilst the statement was generally upbeat there was an undercurrent of caution, as they could push back a hike if inflation doesn’t pick up.

Investors were not enamoured by the Fed's enthusiasm and were in no rush to buy the US dollar. It was the day's weakest performer, losing two thirds of a cent to the euro.

The pound experienced its biggest drop in in two weeks against the euro towards the end of the week, as investor speculation that the Bank of England (BOE) will lower interest rates for the first time in more than seven years on August 4th rapidly morphed into expectation. In fact sterling fell versus all of its 16 major peers after swaps pricing indicated a 100 percent chance that the BOE will cut its key rate from a record-low 0.5 percent, where it’s been since March 2009. This represents a significant shift in the banks stance on monetary policy when we consider that markets were only pricing in around a 15 percent chance of such action on June 23rd – EU referendum polling day.

The euro added half a cent on the week and strengthened by a cent against the pound.

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