Interest Rates: August 14
Short-Sterling Conundrum Enough of the US yield curve conundrum, look at the short sterling market. A month ago the futures were discounting a UK base rate of 4.25% by year-end. The Bank of England (BoE) duly obliges and reduces rates by 25bps to 4.50%, and short sterling sells off, with the December contract now implying no change over the coming months. Of course, the decline in eurodollar futures over recent weeks has weighed on the sterling market, as well as euribor too. However, the market is definitely of the opinion that rates are on hold for the foreseeable future. This has helped the pound recover more strongly against the dollar than has the euro, for example, as interest rate differentials still favour considerably the UK currency – although we see cable finding strong resistance in the 1.8300 area. Furthermore, BoE governor Mervin King is giving nothing away as to future interest rate direction. He has also been suggesting that investment and consumption will pick up in H205, remarking that the strength of the FTSE is an indication of future economic strength. A fair point, but it would also need a revival in the housing market to kick-start consumer spending. Whilst house prices have stabilised, they are not yet starting to trend upwards again. Moreover, the high street is feeling the pinch, with the UK consumer very much on the back foot at present. Indeed, greater living expenses – council taxes and energy prices – as well higher indirect taxation are having a considerably negative effect, stretching the average household income. With this in mind, we still expect the next move in UK rates to be lower. That said, the technical picture of the short sterling market is not so conclusive. Looking at the December 2005 contract, key support exists at 95.50, a break of which would suggest further declines to 95.50 (4.70%). The fundamental view, though, suggests that 95.50 would hold allowing the market to head towards 95.60 resistance. If US bond yields continue to ease this coming week, and oil prices stay firm, this is a distinct possibility. Any break of 95.60 sets up gains to 95.70 in the first instance.
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