Sterling Warning, ECB M3 and Swiss Resilience

One noteworthy take away from this week's price action is the under-performance of sterling. It's 1% loss against the dollar makes it one of the weakest currencies, second only to the New Zealand dollar, which was undermined by a swing in rate expectations following the devastating earthquake.

Sterling continues its under-performance today, perhaps weighed by the downward revision to Q4 GDP to -0.6% from -0.5%. ONS maintains that the weather still accounted for 0.5%. The details released were disappointing and, one would think, supports the less hawkish members of the MPC. GDP was still flattered, for example, by a 0.7% rise in government spending, which is unlikely to be repeated. Private consumption had all but stagnated (+0.1%) and that was before the VAT hike. Gross fixed capital formation slumped 2.5%. The implied yield on the June short sterling futures contract has fallen form 1.27% at midweek to 1.06% earlier today.

Sterling support is seen in the $1.5960-$1.6000 band, which may be a neckline of a double top pattern, and if convincingly violated, would project toward the $1.5700-$1.5800 area, which corresponds to retracement objectives of this year's advance. The five-day moving average is likely to move below the 20-day average early next week for the first time since Jan 7th. Often sterling appears to lead the direction of the euro. Although the quantitative relationship is not overwhelming, it may at least offer a note of caution to dollar bears.

There are two pillars of ECB monetary policy: Inflation and money supply. German states are reporting CPI figures today and the pace of inflation in February for the country is likely to edge above the 2% level, owing mostly to food and energy. While the measured inflation in the euro zone may also rise further, the other pillar is not confirming inflation risks and this should be comforting to the monetarists at the ECB. Money supply, M3 rose at a 1.5% pace in January, well below the 2.1% economists had forecast and slower than the 1.7% rise in in December. The 3-month year-over-year comparison the ECB uses to smooth out some of the volatility stands at a mild 1.7%, not the 2.0% the market had expected and is only slightly higher than the 1.6% pace of the previous three month period. That said, private sector loans accelerated to 2.4% from 1.9%.

The ECB wants to normalize its liquidity provisions, getting rid of the 3-month facility and forcing banks back to the more customary one-week and one-month facilities. This coupled with anti-inflation rhetoric is the most the can reasonably be expected form next week's ECB meeting. Meanwhile, overnight borrowing form the ECB is also coming back to more typical levels from the distortion that was apparently a reflection of the deposit sales by a couple of Irish banks. Lastly, the decline in the retail sales PMI to 49.9 in February from 55.8 in January is disappointing and cannot be simply written off as weather related.

While the euro has enjoyed strong upside momentum since the middle of the month, even if within choppy price action, the euro approached the month's high recorded on Feb 2 near $1.3860 and encountered selling. Month-end considerations and some caution ahead of the outcome of the Irish elections may be playing a role. Relatively firm oil prices continues to be seen by many as dollar negative and more hawkish rhetoric is expected from ECB officials, leaving many short-term players still inclined to buy euro dips. Only a break of the $1.3640-80 band would erode sentiment.

The Swiss economy appears fairly resilient in the face of the strength of the Swiss franc. The KoF leading indicator unexpectedly rose in Feb (2.18 from 2.16). Switzerland reports Q4 GDP on March 1. The economy is expected to have expanded by 0.5% after 0.7% quarter-over-quarter in Q3. In contrast, note that the German economy expanded 0.4% in Q1 after also expanding 0.7% in Q3.

Elsewhere, the latest household credit data from Sweden shows the five interest rate hikes since last July are beginning to bite. Credit growth slipped to 7.7% in Jan, the lowest in eight years. The central bank wants it to slow further. In addition to the higher rates, the macro-prudential policies, requiring mortgage lending be capped at 85% of the property value (since October) may also be having an impact. The euro has corrected higher against the krona this week and has neared the initial corrective target SEK8.85.