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The pound hit a 7 month high against the euro in early trading

A day of extremes in the financial markets as the pound hit a 7 month high against the euro in early trading before lending the day more than 1% down against the single currency.

In UK data, the Markit/CIPS purchasing managers´ index for the construction sector fell to 50.1 points in September, from 51.7 the month before. Consensus estimates were for a reading of 51.7, following on from a reading of 52.6 the month before. Of particular significance is the fact that the contraction seen in new orders was behind the slowdown in output growth, the first since February 2010.

This increased speculation that tomorrow the Bank of England (BoE) will announce an extension to the Quantitative Easing (QE) program from £200 billion to support the economic recovery in the UK.

Consequently, the euro enjoyed a relief rally, pulling off an eight month low against the dollar and a seven month low against the pound after receiving a boost from Federal Reserve Chairman Ben Bernanke’s downbeat assessment of the US economy. Bernanke downplayed the inflation risks and the likelihood of more quantitative easing measures in the US but said the US central bank would take further steps to sustain a recovery if it felt this was necessary.

ECB President Jean-Claude Trichet said the ECB should avoid financing bailouts in a speech yesterday. Sentiment towards the euro was also helped by news that France and Belgium had come to the aid of Dexia, a large Belgium based Bank. Both governments are part owners of the bank.

With the current risk aversion theme dominating the markets, the pound fell to a 13 month low against the dollar on speculation over what the BoE may do on Thursday.

However, the euro’s upward momentum was checked overnight after ratings agency Moody’s downgraded Italy’s credit rating by a full three notches from Aa2 to A2. A negative outlook was given.

“The downgrade reflects the weight of these growing risks relative to some positive credit attributes. These include a lack of significant imbalances in the economy or severe pressure on private financial and non-financial sector balance sheets, as well as the actions undertaken by the government over the summer” advised a Moody’s spokesperson.

The markets also have an eye on the European Central Bank (ECB) policy meeting tomorrow. There is some speculation that the ECB may be looking at cutting euro zone interest rates from their current 1.5% level to stimulate growth in the euro zone economies and this brought to a halt the rise in the euro.

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