UK Awaits Wednesday as US Dollar Rebounds

Focus for this week falls firmly on Wednesday as the coalition plans to cut average spending in government departments by a quarter as it tackles a record budget deficit in the UK.

The comprehensive spending review will unveil that the coalition plans to cut departmental budgets by £83 billion and achieve the rest of the tightening through tax increases such as the VAT 2.5% hike in January.

Measures that we already know about are the proposed scrapping of child benefit from 2013 for households where either parents earn over £44’000 per year.

This in addition to the apparent 25% cut over the next 4 years in certain departments of the NHS will no doubt hurt the already weakened pound and further hinder any chances of the forex markets for sterling sellers reaching the dizzy heights that we enjoyed during the summer.

Looking at the markets, early trading over night Sunday into the early session in Europe has seen the dollar stabilise against a basket of currencies and rise against a 10 month low versus the Euro and Sterling after technical indicators pointed to the possibility of a further short-covering rebound.

The dollar’s rise coincided with a rise in the longer-term U.S. Treasury yields on Friday as the yield curve steepened after comments from Federal Reserve Chairman Ben Bernanke, as investors bet the Fed would be successful in generating more inflation.

Traders covering short positions benefitted after the dollar had been heavily sold following further talk of Quantitative Easing which now looks like it has been pretty much priced in to the market.

A flood of comments from central bankers over the weekend has also appeared to have clouded the outlook for the forex markets, with a number of European officials including Jean-Claude Trichet, calling fro greater exchange rate flexibility.

Overall however, sentiment remains against the US Dollar and there is a risk that it could come under renewed pressure if data releases over the course of this week disappoint.

Reports to look out for include September’s industrial production as well as housing starts and permits for the same month. With US monetary policy a key focus right now, markets will also be paying particularly close attention this Wednesday’s release of the Fed’s latest beige book.

This document will form the basis for discussion at the early November FOMC meeting when markets will await whether quantitative easing is in fact another option.

Sterling has started the week positively compared to Friday’s prices against the euro, pushing close to the 1.15 level after a sharp 3.1% rise in the UK Rightmove house price index for October, which is in contrast to a number of recent reports showing a decline in house prices in the UK.

A boost in sterling may well be short lived of course with Wednesday’s announcement firmly in focus, and depending on the reaction the budget cuts we may well see medium to longer term outlook for the pound take shape later this week.

We will of course keep you update with the latest news as we get it throughout the day.