CHINESE CENTRAL BANK RAISES INTEREST RATES TO 6.06%

The British Pound fell back from a high of 1.6161against the USD and tested lower end support against the Euro yesterday as Chancellor of the Exchequer George Osborne announced plans to temporarily raise taxes for local banks. Mr. Osborne said U.K. banks will be charged 0.1% on short-term liabilities and another 0.05% for longer-term liabilities for the next two-months, which is expected to generate an additional GBP 800M in tax revenues. As the private sector activity remains subdued, the extra burden on the banking system is likely to hamper the outlook for future growth. Despite this weakness or shorter term correction against its major counterparts Sterling remains firmly up on the day this morning with all focus on tomorrows Bank of England Interest Rate decision.

China’s central bank announced yesterday that it was raising interest rates for the third time in four months. The People’s Bank of China said in a brief statement that it would raise the one-year deposit and lending rates by 0.25%, taking the rates to 3% and 6.06% respectively.

The U.S. dollar and Swiss franc fell across the board on Tuesday, with more losses seen likely, as investors ventured away from safe-haven currencies after tensions in Egypt eased. The euro, on the other hand, recovered broadly, lifted by demand from Asian central banks and buying against the Australian dollar after a Chinese interest rate hike fueled concerns over that country’s economic growth and demand for commodities. Analysts, however, said the euro’s rally against the dollar could be short-lived as comments from European Central Bank President Jean-Claude Trichet last week had damped down expectations of a near-term ECB rate hike.

Following on from its decision to hike interest rates on Tuesday, China’s central bank set the yuan’s midpoint against the dollar at a level that represented a 17-year high for the Chinese currency. The People’s Bank of China set the U.S. dollar parity rate at 6.5850 yuan, down from its previous fixing of 6.5860 yuan.

Currency trading market correlations to Gold, the S&P 500 Index, and other key barometers for financial market risk sentiment make pairs such as the Australian Dollar/US Dollar good proxies for trading broader trends. The Australian Dollar remains highly correlated to Gold prices as both have rallied noticeably through very recent trade. The AUD overall remains strong and is a key performer when the markets seek higher yielding currencies particularly when other key currencies offer no yield premium and return on invested funds. Overall few correlations remain quite as stable as the Australian Dollar and Gold prices, which provides a good indication for anyone tracking AUD price movement – it also provides a good way of hedging against commodity based positions.

Also highly correlated to commodities the Canadian Dollar has historically been a similarly good proxy for trading movements in Crude Oil prices, but the said correlation has broken down noticeably amidst recent geopolitical tensions and their effects on oil futures. The Loonie has instead been quite closely linked with the US S&P 500 index thea key barometer for broader financial market risk sentiment.

The Bank of England starts it monthly 2-day policy meeting today. There is some talk in the market that the central bank could move to increase interest rates in order to keep inflation pressures under control. However, the consensus view is for no rate change again this month. It is likely we will see profit taking with the Pound today as investors wait for tomorrow release, markets are lacking clear direction particularly with the lack of fundamentals due for release throughout today. Buyers should look to work protective Stop orders before tomorrows release to minimise any potential losses as volatility is likely.

Market Commentary by Tom Trevorrow