With the poor health of the Spanish economy in the spotlight and surprisingly poor housing data out of the US, the dollar started to gain on safe haven demand again. Data published Wednesday showed housing starts in May down 10.0%--far weaker than expected--while industrial production increased 1.2% last month--more than forecast. Building permits also dropped -9.9% and the NAHB housing market index also dropped sharply by -5 pts to 17 in June. Many think the drop in housing starts reflects the end of the homebuyer tax credit at the end of April. The question being asked by many investors is whether the dip is temporary or it its the start of another down-turn. Most think it is temporary due to the contrast with the industrial production data which was positive. Manufacturing is benefitting from the recovery in global demand whilst housing still has to deal with oversupply. It may take time for the economy to work down the “excesses that grew in some sectors over the past decade.” Other US data was broadly positive with PPI slowing less than expected to 5.3% YoY in May and core PPI up more than expected to 1.3% YoY. Capacity utilization was also up to 74.7%. The dollar eased 0.1% to $1.4812 against the Pound and was 0.2% weaker at ¥91.42 against the Yen.

   The euro retreated from a two-week high against the dollar on Wednesday as worries over the health of Spain’s finances weighed on the single currency. Reports that the European Union, the International Monetary Fund and US Treasury were drawing up a liquidity plan for Spain that included a credit line of up to €250bn ($308bn) were later denied by the European Commission. But the benchmark spread on Spanish government bonds rose to an all time high of 223.5 basis points as the rumuors spread. The IMF Managing Director Strauss-Kahn is set to meet Spanish Prime Minister Jose Luis Rodrigo Zapatero later on Friday but Spain denied it was to discuss a bailing out and when questioned an EU official declared the rumours as "rubbish.” According to J.P Morgan. fears over Spain are overexagerated because although funding markets have been closed to Spanish issuers for some time the same has been true for all European issuers and whilst Spanish banks may have increased their borrowing at the European Central Bank their funding requirements were in line with the European average. Spain is far from in Greece's situation. With a debt to GDP ratio below 60% this year, it doesn't face Greece-style solvency issues. And despite rising 0.4% this week, Spain's 10-year bond yield is still below 5%, which is less than Greece is paying on its IMF facility. Indeed, Greece didn't seek emergency help until its two-year bond yield reached 10%; Spanish two-year bonds currently yield 3.3%. On this basis, there's no reason for Spain to ask to access emergency funding yet. Economic data released by the ECB showed Euro-Zone inflation pushed higher for the third month in May as the annualized rate pushed to 1.6% from 1.5% in the previous month, while the core gauge for price growth held steady at 0.8% after falling back from 1.0% in March. As price pressures hold below the 2% target for inflation, the ECB is likely to maintain a dovish outlook for future policy and is expected to support the economy over the coming months as the governments operating under the single-currency aim to tighten fiscal policy and scale back on public spending. The euro hit a high of $1.2355 against the dollar, its strongest for two weeks, before easing to stand $1.2310 at the close of the session. It was up against the Pound to £0.8355.

   The British Pound pared the overnight decline against the greenback and pushed back above 1.4800 as economic data reinforced an enhanced outlook for future growth. However Sterling failed to hold on to its gains as growing fears over European sovereign debt made the market risk averse as the session developed and the pound ended the day lower against most of its counterparts. Figures released yesterday showed unemployment claims for unemployment dropped 30.9K in May, exceeding expectations for a 20.0K contraction, while the claimant count rate unexpectedly weakened for the second consecutive month, with the reading falling back to 4.6% from 4.7% in the previous month, which is the lowest reading since April 2009. Average weekly earnings including bonuses expanded 4.2% during the same period, which fell short of projections for a 4.5% rise. As growth prospects improve, we may see a shift in the BOE’s economic assessment, but Governor Mervyn King is likely to maintain support for the real economy over the coming months as he aims to encourage a sustainable recovery in the region. Sterling ended the session down at $1.4729 against the dollar and down to ¥134.66 against the yen.

   The yen rose as U.S. housing starts plunged in May, adding to the negative tone in markets and Spanish debt fears sparked a weakening in the Euro. In its monthly report, the BOJ kept its economic assessment unchanged. The bank said that "Japan's economy shows further signs of a moderate recovery, induced by improvement in overseas economic conditions," and expected the economy is "likely to be on a recovery track" ahead. Also, while "employment and income situation has remained severe", "the degree of severity has eased somewhat." Inflation outlook was unchanged with "year-on-year pace of decline in consumer prices expected to slow as a trend in the aggregate supply and demand balance improves gradually." The yen closed marginally stronger at ¥91.42 against the dollar and was up to ¥112.55 against the euro.

Analysis prepared by:

Joaquin Monfort
Forex4you analyst