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Forex: Higher US Core Consumer Prices Fail to Boost Dollar Gains

DailyFX Fundamentals 10-19-04

By Kathy Lien, Chief Strategist of

·Higher US Core Consumer Prices Fail to Boost Dollar Gains
·Eurozone Factory Activity Contracts in August
·Swiss National Bank Says That They Are Comfortable With The Current Level Of Rates


The Euro remains bid, but the rally appears to have gradually become overextended. Sentiment is extremely anti-dollar at this point despite a higher than expected US core CPI report. Although industrial production contracted by 0.6% in Europe during the month of August, the size of the contraction on a monthly basis was less than expected, but the contraction on an annualized basis was more than expected. Regardless, the region’s manufacturing sector has been slowing since the second quarter. This underscores the difficulty that the ECB must be facing. Yesterday, the Eurozone reported that the annualized rate of inflation in the month of September fell from 2.3% to 2.1%. Despite the decline, inflation has been above the ECB’s 2% limit for five months. However the ECB has been unable to raise rates to bring inflation back in line in fear of stalling growth. Being in such a difficult predicament suggests that the ECB will most likely remain on hold for at least the next 4 to 6 months.


A stronger than expected core CPI report provided the dollar with momentary relief. Core inflation, which excludes the more volatile food and energy components increased from 0.1% to 0.3% m/m in September. Core prices were led higher by a sharp surge in the cost of hotel and motel accommodations. Meanwhile headline inflation increased from 0.1% to 0.2%. Although the pace of growth was rather tame, energy prices are expected to push the headline index higher in October after having breached $55 a barrel this week. However, the acceleration in consumer prices is still not a huge concern for the Federal Reserve. Last week, Greenspan said that while record crude oil prices are having a ``noticeable'' effect on the economy, they aren't high enough to spark inflation and slow growth like the U.S. experienced in prior energy shocks. In fact, Federal Reserve President Poole echoed these sentiments today when he told reporters that inflation has not “started ringing alarm bells.” Nevertheless, with extremely accommodative monetary policy, the Fed is on course to continue tightening monetary policy this year – the uncertainty is whether the hike will come in November or December. Meanwhile the Swiss National Bank cut its 2005 growth forecast to 2% from 2.3% citing downside risks and that “everything is more or less related to oil.” With regards to interest rates, SNB Roth says that they are currently in a “comfortable situation” after having increased interest rates by 50 basis points this year.


Although the pound recorded some gains against the dollar today, the overall outlook for the pair remains dismal. Tomorrow we are getting the Bank of England minutes from the Oct 6-7 meeting. If you recall, last week Bank of England Governor Mervyn King said that he has not completely written off further rate hikes. Although he did acknowledge slowing growth, he noted that the monetary policy committee is carefully monitoring economic data to ensure that inflation does not increase surprisingly. This same theme should resonate in the October minutes – that is although the BoE voted unanimously to leave rates unchanged and will most likely refrain from raising them in the near future, they are monitoring economic developments and could adjust policy as needed. At this point, December short sterling futures are only pricing in a 35% probability of another rate hike in December. In our opinion, we have already seen the last rate hike back in August.


The dollar broke down against the Japanese yen today as the yen finds some relief from the retracement in oil prices. It appears that the pair is more sensitive to a decline in oil prices these days than its persistent rallies. Declines into the 108 handle and even further into the 107 handle always sparks fears of Bank of Japan intervention. However, the BoJ has refrained from intervening in the market this fiscal year despite the fact that USDJPY was trading at these levels back in July. If anything, verbal intervention is more likely at this point. Interestingly enough, the Nihon Keizai Shimbun reports that in a report due for release on October 29, the Bank of Japan will forecast that consumer prices will increase modestly in fiscal year 2005. This means that they may be looking at gradually removing excess policy accommodation in late 2005, early 2006.


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