Morning Currency Wrap for Tuesday January 18, 2011

Rising Interest Rate Expectation Due To Inflation  - It looks like to me that we could be in for a renewed bought of across the board USD weakness as the markets digest changing interest rate expectations. Why do I say this, one word, INFLATION. Firstly, the GBP jumped in overnight trading after a report showed inflation accelerated faster than forecast in December, fueling speculation that the Bank of England may need to raise borrowing costs. CPI  accelerated to 3.7% last month from 3.3% in November, against an expected increase of 3.4%. Secondly, last week's hawkish comments by ECB President, Jean-Claude Trichet, were confirmed by the 2.2% increase in December euro zone CPI. These two facts have moved forward possible interest rate hikes for 2011. Meanwhile, inflation in the U.S. is forecast to  rise to 1.7% this year from 1.63% last year causing interest rate expectations to be pushed further out into 2012. Yes I know that UK's austerity program will cut into GDP growth and that the euro zone is still being hampered by sovereign debt vows, but the U.S. is also staring at both those problems. Back to the markets, the Euro managed to rise after an influential German survey pointed to robust growth in Europe's largest economy and on speculation that efforts by euro zone’s policy makers to prevent the sovereign-debt crisis from deepening may succeed. The ZEW's headline economic sentiment indicator surged to 15.4 points in January from 4.3 points in December, which was better than the 6.8 points that was forecasted. Also, euro zone finance ministers pledged this week to strengthen the safety net for debt-strapped countries and indicated they don’t face pressure for immediate moves to tame the fiscal crisis. In Asia, the Yuan rose to a 17-year high against the USD before Chinese President Hu Jintao meets with President Barack Obama tomorrow in Washington. The move comes after a bipartisan group of U.S. Senators said yesterday they will pass legislation this year to push China to strengthen the currency. In Canada, after hitting a two and a half year high against the USD in overnight trading, the CAD softened after the Bank of Canada kept interest rates steady at 1%. The Bank of Canada indicated that the economic recovery has gathered strength both at home and abroad, but not enough to encourage it to start raising interest rates. The BOC did upgrade its growth forecast for the economy to 2.4% this year and 2.8%t next year, up slightly from the 2.3% and 2.6% growth rates it had forecast in October. The BOC did signal that it is clearly worried about the persistent strength in the CAD, which is currently trading over parity against the USD.