EUR / USD
Euro-zone production data remained gloomy with a sharp 1.6% decline in French production and a 0.7% drop in Italian output for January with the Euro initially dipping lower during Thursday’s European session. There was a firm recovery in Euro-zone equity markets with financial stocks rallying strongly after a run of heavy losses which curbed defensive Euro demand. There were rumours that the ECB could buy banking-sector bonds as part of any extended quantitative easing programme. In congressional testimony, Fed Chair Yellen warned that financial conditions were now less favourable and that the decline in equities, allied with a strong dollar, would have a negative impact on US growth. Yellen also stated that if the economy was to disappoint a lower path of federal Funds rate would be appropriate. In this context, the Fed was watching global markets very closely. She was, however, still broadly optimistic surrounding the outlook and she specifically did not rule out rate increases at forthcoming meetings with gradual rate increases still likely. Overall, markets had expected initial comments to be slightly more dovish and had already moved close to pricing out any possibility of a rate increase in March. In this context, the dollar rallied after the comments with the Euro dipping towards 1.1150. The gains were not sustained with evidence of underlying position liquidation and the US currency retreated sharply. Volatility intensified late in Europe with the Euro recovering strongly as the dollar lost ground. As longer-term bullish dollar expectations tended to fade as the Euro moved back to above the 1.1300 level before edging slightly lower on Thursday.
Although risk conditions were generally more favourable during the European session, the dollar still struggled to make any impression on the yen with further selling interest above the 115.00 level. US bond yields edged lower in US trading while there was a retreat in US equity markets which pushed the yen stronger once again. There was a dollar slide to fresh 15-month lows below 114.00 in very choppy trading conditions and selling pressure intensified late in New York with a slide towards 113.00 as US 10-year yields retreated to fresh 12-month lows below 1.70%. Although Japanese and Chinese markets were closed for holidays on Thursday, there was further volatility with the dollar retreating sharply again to fresh 14-month lows below 112.50. There will be additional demands for intervention to weaken the yen and pressure for the Bank of Japan to ease monetary policy further with high volatility continuing.
Headline UK industrial production data was significantly worse than expected with a 1.1% decline for December following a revised 0.8% drop previously. Although led by a drop in energy and mining output, the manufacturing data was also weaker and there will be a slight downward revision to fourth-quarter GDP data. After initially retreating, Sterling gained support from improved risk appetite and a peak near 1.4580 against the dollar. Sterling then retreated sharply against the dollar and failed to sustain a sharp advance against the Euro in volatile trading conditions as risk appetite tended to deteriorate There were still underlying political and economic concerns which curbed potential buying support. The latest NIESR GDP estimate also recorded a slowdown to 0.4% in the three months to January while the RICS house-price index was unchanged at 49% in the latest survey. Political factors will be watched very closely ahead of next week’s EU Summit with Council head Tusk still battling to secure support for the UK re-negotiation deal.