Kathleen Brooks, research director at Forex.com, gives her views on the news and events affecting currency markets.

The pound takes a dive

An improvement in the UK’s CPI data for March has weighed on the pound as the market reduced its expectations for a near-term rate hike. The inflation rate fell to 4 per cent in March from 4.4 per cent in February. This was the first fall in the annual inflation rate for seven months and immediately caused a drop in UK yields.

Two-year UK government yields dropped nearly 10 basis points since the announcement and the yield on three-month short sterling futures, which measure interest rate expectations closely, also fell. Right now the market is still expecting one rate hike in the next three months. However, today’s drop in inflation combined with the record monthly fall in the British Retail Consortium measure of retail sales for March, suggest that the Bank of England may hold off hiking rates in the near-term. We tend to think that the central bank may not actually hike rates until headline inflation starts to moderate, thus freeing up the consumer to spend more.

All-in-all we think this is bad news for sterling. We expect to see sterling fall, although not collapse, in the coming months. But there is a caveat with this as part of the strength in the pound comes from weakness in the dollar, so you can’t trade the UK currency in isolation. 1.6400 looks like the high for now, while 1.6000 is fairly good support on the downside.

Elsewhere, risk has taken a bit of a fall today as the market digests news that Japan’s nuclear disaster is worse than expected, oil prices continue to rise after the latest Libyan peace plan failed and the International Monetary Fund (IMF) revision lower to 2011 growth in the US. The IMF global economic outlook, released yesterday, stated that the Fund’s chief concern for the global economic outlook was elevated oil prices. Although we don’t think we are at the tipping point where high oil prices weigh on growth, it is likely to dent sentiment towards stocks and commodity producers. Indeed today we have seen stocks come off fairly sharply as people start to question the impact of high commodity prices on the global economic recovery.

UK oil prices have recovered today, which has lent some support to AUD/USD, which follows the trajectory of commodity prices closely. It fell to a low of 1.0340 during the Asian session before recovering towards 1.0480/90.

Elsewhere, the German ZEW survey was mixed. The current situation component of the survey, which measures investor sentiment in Europe’s largest economy, rose to 4-year highs of 87.10; however, the forward-looking economic sentiment component fell sharply to 7.6 from 14.1 in February. The market has brushed this off however, and is concentrating more on the revision higher in German CPI inflation for March. It rose to 2.3 per cent, from 2.2 per cent. The overall Eurozone figure is released on Friday, and the German data makes a higher reading more likely. This may keep the pressure on the European Central Bank (ECB) to continue to hike rates to stamp out price pressures, and we have seen a fairly good recovery in the single currency this morning.

Now that the ECB has pulled the trigger and hiked rates growth expectations are going to be key for the euro, as the market tries to estimate how far the ECB will go with its tightening cycle.

The dollar is weaker after some dovish comments from San Francisco Federal Reserve president Janet Yellen, who said that rising commodity prices do not warrant a rate hike. However, Yellen and the other Fed dove – William Dudley - both noted in speeches yesterday that inflation expectations need to be watched carefully. They have risen to their highest level since September 2008. However, US two-year Treasury yields are barely unchanged after hitting resistance at 0.8 per cent.

The yen strengthened overnight as another after-shock hit Tokyo fuelling expectations of yen repatriation. However, it has since come off and USD/JPY is trading at 84.30.

Ahead today the Bank of Canada is expected to keep rates on hold at 1 per cent at 1400 BST. Also there may be some volatility in the pound as investors digest the UK inflation data and the prospects for a rate hike.

US equity earnings got off to a weak start yesterday when Alcoa the US aluminium maker announced results below analyst expectations. Look out for earnings from JP Morgan tomorrow, Google on Thursday and Bank of America on Friday.