The GBP was supported by yesterday’s release of a better than expected UK CIPS manufacturing PMI for December, with the data raising hopes that the UK’s recovery momentum can be maintained going into 2011. The GBP/USD rose sharply following a robust manufacturing report but failed to break from its bearish trend pattern as the pound has been under pressure on the back of a dimming growth outlook.

The December PMI reading improved to 58.3 from 57.5, beating expectations for a decline to 57.2 and reaching the highest level in 16 years. It is evident we have started to see yield expectations grow in importance in determining direction for the pair with its correlation rising to 32%, putting a greater focus on U.K. fundamentals. Meanwhile, risk trends have started to lose influence as we see broader markets begin to decouple. Stock prices and the pair have diverged in recent weeks with equity markets now explaining 49% of price movement compared with 60% a month ago.

The euro fell sharply versus the dollar in late trading yesterday, remaining under pressure overnight as markets continue to respond to hopes for a strong performance from the US economy this year. Concerns about eurozone sovereign debt also continue to overshadow the single currency. Data released yesterday afternoon showed that US factory orders rose unexpectedly in November, growing by their highest level for eight months.

Meanwhile, the minutes of the December Fed meeting show the central bank’s acknowledgement that the rebound seen in data in recent weeks could well continue, though it is in no rush to change policy stance. A sharp retreat in commodity prices (particularly gold, copper and oil) also drove down commodity linked currencies like the AUD, which also helped the US dollar. Indeed, oil fell for the second day running as prices corrected after a sharp year end rally. Sterling was one of the few currencies to rally versus the dollar yesterday, though it did struggle to hold its gains over the day.

Markets will now turn their attention to today’s release of the US non-manufacturing ISM survey for December, as well as last month’s ADP employment report, which should provide a steer ahead of the release of Friday’s official payrolls data.

Market commentary by Tom Trevorrow
Senior Fx Analyst