The pound bucked the trend on a quiet start where trading was otherwise marked by further dollar strengthening after the Bank of England revealed a poor combination of weak growth and high inflation. Meanwhile sentiment towards the euro is reaching the opposite extreme of where it stood one week ago in the run-up to the ECB meeting. Since the ECB appeared to soften its stance the single currency has weakened by seven cents versus the dollar.

Fx Brief

British pound – The Bank of England’s quarterly assessment for the British economy keeps the MPC boxed into a tight corner. The Bank states clearly enough that inflation is likely to rebound from its current 4% to above 5% this year and through the end of 2012 is likely to remain above the target ceiling of 2%. That’s pretty much all you need to know about today’s report. Governor King has tried his best recently to ward off demands for tighter monetary policy that has seen a split-vote for several quarters. His view of inflation is pretty sanguine. Like the Fed Mr. King believes that it is not only transitory in that it is largely related to rising energy costs, but also lays the blame for much of the higher base in government tax increases. He remains deeply concerned that growth is likely to weaken before it stands a chance of rebounding on account of fiscal cuts from spending reductions to job losses. The health of the nation’s banks remains in poor shape given ambivalence towards a desire to lend. And the legacy of the last decade has left households and corporations deeply indebted and more sensitive than in recent history to rising interest rates. Investors overlooked a litany of legitimate concerns and baked an imminent tightening of monetary policy back into the pound lifting it to $1.6500 and 87.07 pence per euro. One would think that if the bank was serious about addressing inflation based upon the strength of today’s report it would have acted at the May meeting last week and released its findings early. The conclusion is that the Bank’s top brass is more likely to dig its heels in further arguing that downside risks to growth are more of a real threat even as inflation remains temporarily high.

Euro – Sentiment worsened for the euro after hot gossip over a further package of financial assistance gained traction. However, the appearance that its European partners are throwing rocks and stones along the recovery path with the intention of hindering the journey of the government of Greece is once again worrisome for investors. On the table is an extension of existing maturities, the prospect of reduced interest rates on its debt and the offer of more money in order to circumvent the need to tap a tetchy capital market. Yet Germany’s Chancellor Merkel seems to be forming a further barrier against talks possibly taking place in the background. She says that in order to deserve any extension package Greece first needs to continue its deficit-reduction process. Ms. Merkel also says that there is a will amongst partners to rebuild the foundations but that Greece must participate and not stand idly by. The single currency recently traded towards its session low and buys $1.4367.

U.S. Dollar – The dollar weakened earlier Wednesday and traded beneath Monday’s weakest point. As crude oil prices put a dent in the recovery for the commodity rebound and as sentiment weakened towards the euro, the dollar index recovered to stand at 74.66 and as New York trading commences, the dollar is testing its best level of the day. The economic calendar is light today as investors prepare for initial claims and retail sales data later in the week.

Japanese yen – The dollar also burst to its highest in seven sessions against the Japanese unit and recently traded to ¥81.24. The weakening of the Japanese unit unusually coincides with a weaker reading for pre-market equity index futures and as crude oil tumbles to $102.78 in New York. There is a grain of risk aversion receiving some attention this morning in pre-market hours at least and that appears to be benefitting the dollar more than most in a move investors have not been accustomed to for a while. Typically ‘risk-off’ has ended to elevate demand for the yen at the expense of the dollar.

Canadian dollar – The Canadian dollar earlier rose to its highest in four sessions reaching $1.0487 U.S. cents as dealers favored the unit on rising risk grounds. The Canadian story was strengthened recently by the majority vote putting the Conservatives back into power. Finance Minister Jim Flaherty yesterday stated that he’d use a June budget to announce restoration of fiscal balance by 2014 at the same time as releasing planned tax cuts. The loonie pared its gains but remains higher on the day at $1.0455 cents.

Aussie dollar – The Aussie has also given up a hard night’s work that drove it to as high as $1.0888 and its highest in six sessions. Firm activity data out of China overnight reinforced the view that demand is likely to remain firm from its regional partner even though the world’s number-two economy has more work ahead in terms of taming inflation data, which also rose unexpectedly during April. The Aussie built on the recent words of the RBA, whose Chief Glen Stevens said last week would need to ultimately act further on monetary policy in the face of rising inflation. Traders overlooked the impact of yesterday’s budget and chose to bring in expectations of rising interest rates that would benefit holders of the Aussie unit.