Currency market updates - from Foreign Currency Direct (www.currencies.co.uk)

Wednesday October 3rd 2007

By Simon Eastman - Trading Supervisor

Trading started yesterday with sterling easing against the dollar and euro as investors remained cautious of buying the British currency amid worries about the health of the banking sector and possible interest rate cuts in coming months. Troubles at UK mortgage lender Northern Rock and the big contribution that Britain's finance sector makes to the broader economy have made sterling vulnerable to bad news from banks -- such as statements from UBS, Citigroup and Credit Suisse that their profits will be hit by the credit market squeeze.

Data releases yesterday were thin with just two pieces of Euro zone info out. The producer price index (PPI) increased a mere 0.1% on the month, while they went up 1.7% from August last year, figures broadly in line with the market expectations. August’s PPI increase shows a clear slow down on prices growth which was mainly attirbuted to a decrease in energy prices. The other data release shows Euro zone unemployment was 6.9 pct in August, unchanged from the level in July.

In mid morning trading the pound rose to a two-week high against a basket of currencies, bolstered by talk of a £740 million rescue package for the troubled UK mortgage lender Northern Rock. Sterling has been under pressure in recent weeks by worries about the health of Britain's financial sector and the economy, kick started by news that Northern Rock had fallen victim to the credit market squeeze and been forced to tap up the Bank of England for a last resort loan. This in turn caused mass panic and we all recall the queues outside branches of the troubled bank as customers withdrew over £2 billion in a couple of days.

So talk of a rescue bid for Northern Rock lifted sentiment, at least for now.

"The Northern Rock story had a marginally positive impact on sterling, hence its recovery against the euro," said Marios Maratheftis, currency strategist at Standard Chartered.

"But going forward there are still concerns about the sustainability of the UK economy. The focus is gradually shifting from the U.S. and the UK (housing market) and I would see sterling as an underperformer."

Also helping the pound was news that The Bank of England's second auction, of £10bn, to inject liquidity into the three-month interbank money market, received no bids.

In a repeat of last week's auction, UK banks rejected the opportunity to borrow from the central bank at a penalty rate, set at a spread above the base rate of 5.75 pct and the standing lending facility rate of 6.75 pct.  The BoE plans to have two more such auctions this month.