Dollar Remains Bid

After gapping higher yesterday, sterling has been sent sharply lower today by the lower than expected inflation figures. Just last week, the BOE had indicated that the headline CPI likely rose at a 1.9% year-over-year rate in July. Instead, it has reported a 1.6% rise earlier today.

This sent UK rates lower and dragged sterling down with them. The implied yield of the March short-sterling futures contract fell 4 bp, as did the UK 10-Year yield. Sterling itself filled the downside gap and kept going. It fell to about $1.6635, a level not seen since early April.

It appears the timing of the summer sales may impact measured inflation. Clothing and footwear prices, which had risen in June, fell off again in July. Factory prices were also soft, with PPI input and output prices coming in lower than expected. On top of this,the decline in Oil prices also should weigh on inflation expectations going forward. Brent Oil prices are at 14-month lows today.

Sterling was sold through the 200-day moving average (~$1.6675), which had stemmed a sell-off last week. Our target near $1.6630 has been largely met, and below there we see support near $1.6600. Tomorrow the MPC minutes will be released. The lower CPI figures today would seem to steal the thunder from any dissents, which are rumored. Many observers see risk that Miles, and possibly Weale, dissented in favor of a rate hike, but the lower CPI figures and decline in oil prices show why for the majority it is premature to raise rates.

The euro remains pinned to the base it has been carving out in the $1.3335-45 area for the better part of the past two weeks. We suspect the persistent selling pressure will absorb the bids, allowing the euro to make fresh lows. The next key target is near $1.3230, a retracement objective of the rally from July 2013. The Bundesbank's acknowledgment in its monthly report that the outlook for H2 is weaker than previously anticipated is understood as adding to the pressure on the ECB to act.

It is difficult to make the case, however, that the main problem is interest rates which are too high in the euro area. While the focus on the ECB and its monetary policy initiatives is nearly universal, we question if it can be sufficient. Did the lower interest rates seem to be sufficient, and allowed officials to slow structural reform efforts? Is there not a role for fiscal policy, given the weak domestic demand in the leading economies?

The Australian dollar is edging higher and is the strongest of the major currencies today. It is not immediately clear what the market saw in the minutes to push the Aussie higher. It might be what was not in the minutes, rather than what was in them. There did not seem to be fresh clues to encourage rate cut ideas. The takeaway from the minutes was the official acknowledgement of greater uncertainty surrounding the economic outlook. Its concern about the currency strength appeared to be mitigated by the recognition that there has been a "noticeable easing in financial conditions" and an uptick in inflation in Q2.

With the small gains today, the Aussie is challenging the 20-day moving average (~$0.9335). It has not finished the North American session above the 20-day average since late July. Assuming it does, the next target is seen in the $0.9375-$0.9400 area. RBA Governor Stevens speaks before Parliament tomorrow, which may discourage aggressive action today.

Soft inflation and growth figures weighed on the New Zealand dollar, but support near last week's lows (~$0.8400) held, and the Kiwi recouped half of its losses. It may run into fresh offers in the $0.8465-80 area.

The US dollar has edged higher against the yen, but remains within last Friday's trading range, when a high just below JPY102.75 was recorded. The softness of U.S. 10-Year yields, which had been a good guide to the exchange rate, appears to have been offset to some extent by a strong rally in equity prices. US 10-year yields are struggling to sustain gains above the 2.40% level.

Separately, we note reports indicating that Prime Minister Abe will announce a cabinet reshuffle on September 3. Finance Minister Aso and Economic Minister Amari will keep their posts, according to the Nikkei. The Chief Cabinet Secretary Suga is also tipped to keep his post. The cabinet reshuffle appears to be an effort to shore up support. There is some drama around the creation of a new post for "defense legislation" that the LDP Secretary General Ishiba was offered, but has not accepted it.

The US reports July CPI and housing starts today. The former is expected to tick down slightly at the headline rate and remain unchanged at the core rate while the latter is expected to rise after falling in May and June. We see risk of the CPI on the upside emanating from medical care costs and rents. Minutes from the July FOMC meeting will be released tomorrow.