UK Interest rate decision due this week

The gloomy outlook for the UK economy continued last week. With the Nationwide building society reporting a ninth-consecutive monthly fall in UK house prices, and mortgage approvals reaching a new low, there are few signs yet of an early turnaround in the UK housing market. Although the Pound retreated against the US Dollar, Sterling held firm against the Euro as the latest Euro zone data suggested that faltering economic conditions are not only specific to the UK.

Falling retail spending may be expected when the housing market remains so weak, but the pace of decline has surprised many, with the latest Confederation of British Industry retail survey showing a net balance of 36% of retailers reporting lower sales in July - the worst reading for 25 years. The negative impact on Sterling from the UK data last week was further compounded by a sharper than expected decline in manufacturing activity levels.

However, with inflation still rising the Bank of England (BoE) is expected to keep interest rates on hold on Thursday. If the service sector activity data on Tuesday is weaker than expected, Sterling could lose some support on expectations that the deteriorating growth outlook will eventually force the BoE to lower interest rates to stimulate the economy.

Euro (EUR)

Inflation in the Euro zone increased to a new record high of 4.1% in July, further above the European Central Bank's (ECB) target level of 2%. However, with growth concerns over the Euro zone economy increasing, the ECB faces a difficult task at its interest rate meeting this week.

The latest economic confidence data were worse than expected, with the European Commission.s economic sentiment indicator falling to its lowest level since March 2003. With the recent weakening in Euro zone growth data, the data reinforced expectations that the ECB will leave interest rates on hold for the time being, undermining support for the Euro.

The GBP/EUR rate closed up 0.14% at 1.2682, from 1.2664 a week earlier, benefiting those selling Pounds to buy Euros.

The ECB will announce its interest rate decision this week on Thursday. After increasing interest rates last month, another move upwards would offer support to the Euro. However, if a no change decision is delivered as presently expected, the ECB's statement and press conference afterwards will provide further insight into the ECB's stance on the balance between growth and inflation risks.

US Dollar (USD)

The US Dollar lost ground against Sterling at the beginning of the week, with the GBP/USD rate advancing to around 1.9950 as sentiment over the health of the US financial system remained fragile.

However, the US Dollar went on to more than recoup these losses over the rest of the week. Firstly, a small improvement in consumer confidence provided some relief to the Dollar; this was the first rise since December, having hit a 16-year low last month. The non-farm payrolls employment report also revealed a smaller than expected decline in employment, offsetting the disappointment of a lower than expected economic growth performance in the second quarter.

The GBP/USD rate closed down 0.84% on the week at 1.9737 from 1.9904 a week earlier, benefiting those converting US Dollars into Pounds.

The Federal Reserve.s interest rate policy meeting on Tuesday will be this week.s key release. The lower than expected growth performance in the second-quarter favours a no-change decision to leave interest rates at 2%, but the US Dollar could find further support if there are signs that the Federal Reserve's concerns have shifted more towards inflation risks and less towards growth risks.

Canadian Dollar (CAD)

Sterling made strong gains against the Canadian Dollar at the beginning of the week, trading at its highest level since April above 2.04. However, the Canadian Dollar had recouped some of its losses by mid-week, mainly owing to the influence of UK data and a brief rally in oil prices.

The May Gross Domestic Product report revealed that the Canadian economy unexpectedly contracted by 0.1%, contrary to expectations of a 0.2% rise. Although the GBP/CAD rate was volatile before and after the announcement, the Canadian Dollar settled close to the pre-report levels with little change in investors. perceptions of the future path for interest rates.

The GBP/CAD rate closed at 2.0241, up 0.14% from 2.0212 a week earlier, benefiting those selling Sterling to buy Canadian Dollars.

Highlights this week will include Wednesday.s Ivey Purchasing Managers. Index, an indicator of overall business conditions in the economy, and Friday.s employment report. The Canadian Dollar could lose further support if the data are weaker than expected.

Australian Dollar (AUD)

The Australian Dollar fell against Sterling, with the latest economic data confirming acceleration in the economic activity slowdown. Despite inflation remaining well above target, a significant deterioration in the growth outlook could take precedent and persuade the Reserve Bank of Australia (RBA) to cut interest rates sooner than expected. Building approvals fell again in June, whilst retail sales volumes in the second-quarter fell at the fastest pace in more than seven years.

The GBP/AUD rate closed at 2.1191, up 1.97% from 2.0782 a week earlier, benefiting those seeking to convert Pounds into Australian Dollars.

The RBA will announce its interest rate decision on Tuesday. Until recently markets had rated the likelihood of a hike this year as higher than the likelihood of any reduction, but expectations have changed dramatically in the last month. A surprise decision to cut interest rates this time around could undermine support for the Australian Dollar.

New Zealand Dollar (NZD)

The New Zealand Dollar declined against Sterling for a fourth consecutive week, with the GBP/NZD rate rising above 2.70 for the first time since December 2007. The Dollar fell as weak economic data reinforced investors. belief that the Reserve Bank of New Zealand (RBNZ) will continue cutting interest rates, a view which appeared to be supported by comments from RBNZ Governor Bollard that there is 'plenty of room' to lower interest rates further.

The outlook for the economy remains weak; the fragile state of the housing market was confirmed by building permits falling to a 22-year low, whilst business confidence fell for the first time in four months. The GBP/NZD rate closed 1.42% higher at 2.7168, from 2.6788 a week earlier, benefiting those converting Pounds into New Zealand Dollars.

Markets will focus attention this week on the second-quarter employment report, released on Wednesday. The New Zealand Dollar could lose further support if the report confirms weakening employment growth, undermining confidence in the labour market.

South African Rand (ZAR)

The South African Rand strengthened during the week, with the latest inflation data raising expectations that the South African Reserve Bank (SARB) could opt to increase interest rates again next week. Higher than expected producer and consumer prices in June, as well as stronger than expected credit extension to the private sector, helped underpin support for the Rand.

The GBP/ZAR rate closed down 3.88% at 14.486 from 15.071 a week earlier, benefiting those converting Rand into Pounds.

Thursday's mining and manufacturing data are the only notable releases this week, but are unlikely to impact on the outcome of the SARB's interest rate decision on 14th August. Rand direction is likely to be strongly influenced in the meantime by global stockmarket performance and investor risk tolerance levels.