Sterling regained some ground amid an absence of negative news, but sentiment remained fragile.

The dollar lost ground during much of Tuesday as underlying defensive demand for the US currency faded. Risk appetite dipped late in New York amid doubts over vaccine trials, although there was tentative buying of risk assets on dips.

Euro confidence remained firmer on recovery plan optimism with EUR/USD near 1.0950. Sterling regained some ground amid an absence of negative news, but sentiment remained fragile.

Commodity currencies made sharp gains and the sharp retreat late in New York attracted cautious buying interest. The Swiss franc pared losses when risk appetite dipped, but net demand was weaker.

The headline German ZEW economic sentiment index strengthened to 51.0 for May from 28.2 in April which was well above consensus forecasts of 30.0 and the strongest reading since April 2015. The Euro-zone index also recovered strongly to 46.0 from 25.2. The German current conditions index, however, declined further to near a record low of -93.5 from -91.5 the previous month, illustrating the sharp divergence between current conditions and expectations.

Germany’s IFW Kiel institute warned that the economy was likely to contract more than 7% in 2020. ECB Chief Economist Lane stated that Euro-zone GDP could decline 12% in 2020 under an extreme scenario, maintaining pressure for support measures and a further easing of lockdown restrictions.

EU Commission Executive Vice President Dombrovskis stated that a recovery plan will be presented next week totalling over EUR1trn with a mixture of loans and grants. The aggressive pledge maintained underlying confidence in the Euro. ECB President Lagarde stated that proposals were ambitious, targeted and welcome.

US April housing starts declined to an annualised rate of 0.89mn from 1.28mn previously, the sharpest decline on record while building permits dipped to 1.07mn.

Fed Chair Powell continued to push for additional fiscal stimulus in order to lessen the risks of prolonged unemployment and Boston Fed President Rosengren also pushed for increased congressional fiscal support. The dollar continued to lose ground in European trading with a further dip in defensive demand as commodity currencies posted a fresh advance.

EUR/USD hit highs around 1.0975 before fading later in the day. The dollar also regained some ground as risk appetite dipped late in the US session, but there was fresh dollar selling on Wednesday as the dip in risk assets was seen as a buying opportunity and EUR/USD settled just below 1.0950.

Early in the European session on Tuesday, the Bank of Japan announced that it would hold an unscheduled policy meeting on May 22nd. There were expectations that the bank would announce new measures to provide funds for financial institutions, although there was speculation of further measures. The yen lost ground following the announcement with the Japanese currency also hampered by firm risk appetite, but with USD/JPY selling above 108.00.

There were further concerns over simmering tensions with China which maintained underlying caution. Late in US trading there was also a more pessimistic assessment of Moderna’s coronavirus drugs trail which pushed US equities lower and USD/JPY retreated to the 107.70 area.

The monthly Japanese Tankan manufacturing confidence index declined to -44 for May from -30 previously and the weakest reading since June 2009 while the non-manufacturing index retreated further to -36 from -23 and overall expectations remained weak. The yen was unable to gain sustained support as US equity futures recovered and USD/JPY consolidated around 107.75 as underlying yen demand remained weaker.

Reaction to the UK labour-market data was relatively muted given expectations that the main spike in unemployment will be seen next month. In testimony to the House of Commons Chancellor Sunak confirmed that the unemployment rate was forecast to increase to over 10% in the short term.

Overall risk appetite held firm on Tuesday which provided underlying Sterling support, although it again tended to under-perform relative to other high-beta currencies such as the Australian dollar. Underlying sentiment remained fragile given the difficulties in exiting lockdown measures. Concerns over the EU/UK trade talks were also remained a negative factor.

The headline UK CPI inflation rate declined to 0.8% for April from 1.5% previously and below consensus forecasts of 0.9% as energy prices declined sharply while the core rate declined to 1.4% from 1.6%. The data will maintain expectations of further Bank of England easing, but GBP/USD was little changed around 1.2250.

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