Sterling posted limited net gains with GBP/EUR at fresh 23-month highs near 1.2000 before a correction.

Risk appetite recovered to some extent on Wednesday, although there was still an important element of caution. US bond yields edged lower on the day which provided some limited relief.

Wall Street equities, however, dipped sharply in late trading amid underlying unease over Fed tightening prospects. A small cut in Chinese interest rates helped underpin confidence in Asia on Thursday.

The dollar drifted lower as yields retreated, although moves were limited. EUR/USD advanced to 1.1350 as German benchmark yields broke above 0.0%. Sterling posted limited net gains with GBP/EUR at fresh 23-month highs near 1.2000 before a correction. The Australian dollar posted net gains, boosted by a strong jobs report. The Canadian dollar failed to hold intra-day gains with profit taking after strong gains.

The Euro-zone current account surplus widened to EUR24bn for November from EUR19bn the previous month with a 12-month surplus of EUR320bn and 2.7% of GDP.  There were, however, further portfolio outflows from the Euro-zone with a reversal in these flows needed to provide longer-term Euro support.

The Euro was resilient ahead of Wednesday’s New York open with a slight net gain as commodity currencies posted an advance against the US currency.

The German 10-year bond yield also moved above 0.0% for the first time since May 2019 which provided an element of support for the single currency as markets also considered the potential for a less accommodative ECB policy within the next few months.

Markets will continue to monitor rhetoric from ECB officials closely with scope for the bank to push back against an increase in money-market rates.

The dollar edged lower as yields declined with EUR/USD testing the 1.1350 area.  Relatively narrow ranges prevailed during the US session with the dollar unable to gain significant traction, although commodity currencies weakened as equities moved lower with EUR/USD settling just below 1.1350.

The US Philly Fed business confidence data will be monitored on Thursday, especially after a much weaker than expected New York survey earlier this week. Narrow ranges again prevailed on Thursday with EUR/USD still close to 1.1350 amid a mixed tone in commodity currencies.

US housing starts increased to an annual rate of 1.70mn for December from 1.68mn previously and above consensus forecasts of 1.65mn. Building permits increased strongly to 1.87mn from 1.72mn and above expectations of 1.70mn previously.

US Treasuries secured some respite in early US trading with the 10-year yield retreating from 2-year highs. There were net gains in equities which helped underpin risk appetite and curbed yen demand to some extent, although USD/JPY was unable to make headway and edged lower with a retreat to near 114.25.

Equities dipped sharply late in the US session, although the dollar was able to avoid further selling.

China announced a further easing of monetary policy on Thursday with the 1-year prime loan rate cut to 3.7% from 3.8% while the 5-year rate was reduced to 4.6% from 4.65%. The cut helped underpin risk appetite and futures secured a recovery, although Chinese equities were unable to respond, and President Biden stated it was too early to remove tariffs on China.

Overall, USD/JPY recovered to near 114.50 in early Europe while EUR/JPY advanced to near 130.0.

Sterling was unable to make further initial gains following the latest UK inflation data, but the currency held a firm tone, especially with stronger expectations that the Bank of England would sanction a further interest rate increase at the February policy meeting.

The UK currency gained an element of support from a firmer tone surrounding risk appetite even though there was still significant caution.

Although there was a strong focus on political drama surrounding Prime Minister Johnson, the announcement that coronavirus restrictions in England would be eased provided some support for UK markets and UK equities were resilient which maintained expectations of investment inflows.

In testimony to Treasury Select Committee, Bank of England Governor Bailey stated that the labour market is very tight and that the bank was seeing some evidence of second-round inflation effects.

Bailey also stated that inflation would take longer than expected to decline than had been expected two months ago, especially with concerns that energy prices would not start to decline until the second half of 2023.

Sterling failed to make further headway into the European close, but GBP/USD held above 1.3600 on expectations of a February rate hike. GBP/EUR rallied to fresh 23-month highs above 1.2000 before a limited recovery.

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