Sterling maintained a solid tone against the dollar ahead of the US open on Thursday, but continued to hit resistance above the 1.2500 level. The Euro regained the 0.8500 level which helped underpin confidence with a further advance to the 0.8550 area as Sterling overall lost support with markets still wary over the risk of further medium-term losses. A slightly more defensive attitude surrounding risk appetite curbed Sterling support, although underlying selling interest above 1.2500 against the dollar was the more important factor.
Sources suggested that the government was looking to trigger Article 50 around the time of the March 9-10 EU Summit and the Brexit debate will sharpen again next week when parliament returns from recess. The latest retail sales data is due on Friday and another weak release would maintain expectations that there will be an underlying slowdown in spending as Sterling consolidated around 1.2500 against the dollar.
UK consumer prices declined 0.5% in January and, although the year-on-year rate increased to 1.8% from 1.6% which was the highest rate since June 2014, this was slightly lower than the consensus forecast of a sharper increase to 1.9%.
There was significant upward pressure on transport costs which was offset by a decline in clothing prices.
The data will dampen expectations that the Bank of England may need to tighten monetary policy more aggressively to curb inflation, although there was a larger than expected increase in producer prices which suggests underlying pressures may be building.
Sterling weakened significantly following the inflation data with the UK currency moving back below the 1.2500 level as the Euro moved to the 0.8520 area, although gilts reversed initial gains.
The UK currency was resilient at lower levels and regained support during the New York session as the Euro retreated back below 0.8500. The latest labour-market data will be released on Wednesday with a particular focus on the earnings data.
The US NFIB small-business confidence index edged higher to 105.9 for February from 105.8 previously while there was a stronger than expected reading for producer prices with a 0.6% monthly gain.
In her prepared comments to the Senate Banking Committee, Fed Chair Yellen reiterated that it was dangerous to wait too long before raising interest rates given the risk that disruptive interest rates could then be required which could push the economy into recession.
According to Yellen, the FOMC expects the labour market to strengthen further with inflation rising gradually towards 2%.
Overall, she expected further gradual interest rates to be warranted and that the committee will evaluate whether further adjustment of the Fed Funds rate is needed at forthcoming meetings.
The comments were seen as relatively hawkish with no move to rule out a March hike with Yellen stating that all meetings are live.
Futures markets moved to price in around a 35% chance of three rate hikes for 2017 from just below 30% ahead of the testimony.
The dollar gained ground with the Euro dipping to five-week lows in the 1.0570 area and the US currency held firm on Wednesday.
Euro-zone GDP growth was revised down to 0.4% in the updated flash Q4 reading from the provisional 0.5% which will tend to dampen expectations that the Euro-zone economy is gaining momentum.
There was also a weaker than expected reading for the German ZEW investor sentiment index, although the overall market impact was limited.
The EU Commission revised its 2017 Euro-zone GDP growth forecast marginally higher to 1.6% from 1.5% previously, although this was still lower than the 2016 outcome and the underlying tone remained generally downbeat with a high degree of uncertainty over both domestic and US developments.
The inflation forecast for this year was revised higher to 1.7% from 1.4% previously, but with an expected slowdown to 1.4% in 2018 and still below the ECB target
Sterling was unable to make any headway against the dollar during the European session on Monday, but it was able to strengthen against the Euro for the sixth successive session as the single currency dipped to lows around 0.8460.
According to data from Visa, UK consumer spending slowed to a five-month low of 0.4% in January from 2.5% in December, maintaining expectations that underlying consumer spending will slow during 2017.
The latest UK consumer inflation data will be watched closely on Tuesday and a lower than expected reading would dampen expectations surrounding the need for higher interest rates while any move in the headline rate to 2.0% or higher would increase speculation that the Bank of England could be pushed towards an earlier than expected tightening.
Sterling was able to hold above the 1.2500 level against the dollar on Tuesday with a firm underlying tone
According to the New York Federal Reserve, one-year inflation expectations rose to 3.0% in the latest survey from 2.8% previously and the highest reading since the middle of 2015.
Inflation expectations will be an important element of Fed thinking over the next few months, especially as the FOMC had worried previously that low expectations would prevent a rise in the inflation rate. Dallas Fed President Kaplan stated that the Fed should raise interest rates again sooner rather than later with rates increasing in a gradual and patient manner.
The dollar’s trade-weighted index hit the highest level for over three weeks and the Euro dipped to test support below the 1.0600 level as strong risk appetite curbed Euro support.
Commentary from Fed Chair Yellen will be watched very closely on Tuesday with markets currently putting the chances of a March interest rate increase at around 22%.
Any hints of a March hike would provide further net dollar support as the Euro edged back above 1.0600 on a wider US retracement.