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Friday April 4, 2008 - 15:36:45 GMT
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FX Briefing - Growth weakness is spreading

FX Briefing 4 April 2008


·        Economic upswing is losing momentum in the eurozone

·        IMF forecasts weak global growth and pushes for ECB interest rate cuts

·        But ECB Council set to leave rates on hold for now because of inflation risks

Growth weakness is spreading

Foreign exchange markets remained volatile this week. The dollar had weakened at the end of lastweek, and this movement continued at first. USD-JPY dropped below 99 temporarily, whereas EUR-USD neared 1.59 again. Then, however, the latest economic indicators did not fully bear out the gloomy picture of the US economy which market participants had over the last few weeks. The ISM manufacturing index actually recovered somewhat to 48.6, and the ADP employment index showed a slight increase in private employment instead of the expected sharp decline. Later in the week, the ISM non-manufacturing index also went up a bit, to 49.6.

Given the markets’ pessimistic expectations, this glimmer of hope was probably enough to boost equity markets too. In this environment, the dollar made significant gains. USD-JPY firmed to around 103, whereas EUR-USD approached 1.55. Towards the end of the week, however, the US currency lost some ground again. This was probably partly due to the fact that the US labour market report was about to be published; employment figures are particularly uncertain, and on Thursday it was reported that initial jobless claims had risen sharply from 369 to 407k in the last week of March, which gave rise to increased concern again.

In March, annual inflation in the EMU went up to 3.5%, mainly due to energy and food prices. But ECB representatives are certain to have taken this into account when issuing their hawkish comments last week. Bundesbank president Axel Weber, for instance, had already announced a slight acceleration in inflation. Thus the news had little impact on the market.

Instead, the surprises in the eurozone were on the growth side. First and foremost here were German retail sales, which fell in price-adjusted terms as calculated by the Bundesbank (including cars and petrol stations) by 1.5% in February. The decline, which was the second in a row, was all the more surprising because the ifo institute had indicated a significant improvement in retail sales. Against this backdrop, sales in the euro area as a whole also came as a disappointment. There is no sign yet of private consumption picking up, quite the contrary in fact.

The EU Commission business and consumer climate survey results should also be borne in mind. In contrast to the German business climate figures, the EU Commission economic sentiment indicator fell in March; the decline was caused mainly by the construction and service sector and was most pronounced in Spain, Italy and the Netherlands. This is the first time since 2004 that this indicator has dropped below its long-term average. Furthermore, German industrial new orders also declined again in February, by 0.5% month-on-month, which was rather surprising compared to the development in orders according to ifo.

In our view, the latest eurozone economic data confirm that Europe’s economy is in fact slowing down. This will not have gone unnoticed by ECB monetary policymakers, who are meeting again next week to discuss policy. However, the latest data alone are not yet reason enough for the ECB to put less emphasis on inflation risks and to back down from its recently adopted more hawkish stance. It is practically out of the question that the ECB will cut interest rates at the forthcoming meeting, or even hint at doing so.

Although the ECB’s monetary policy position is clear for now, this does not rule out that the ECB might be somewhat more cautious in its growth outlook. The International Monetary Fund, whose latest forecasts will be officially presented next Wednesday, appears to be much more pessimistic in its growth forecast than the ECB. A month ago, the ECB staff had predicted that eurozone growth would be somewhere between 1.3 to 2.1% in 2008 (and between 1.3 and 2.3% in 2009); according to unconfirmed reports, the IMF estimates that GDP growth will only be 1.3% in 2008, and could slow down even further to 1.1% in 2009.

In view of the impending economic slowdown, the IMF will supposedly push for ECB interest rate cuts in the near future, despite higher inflation rates. Not much is known yet about the IMF’s arguments. However, we think the Monetary Fund is likely to point out the risks of a deeper recession in the US, which in combination with the credit crisis could lead to growth weakness spreading across the globe.

The IMF’s position is probably not all that different from that of the USA. Therefore the US representatives at the G7 meeting of finance ministers and central bank governors could well try to involve the Europeans in their attempts to ease the credit crunch and stabilize economic growth. It will probably be difficult for the Europeans to refuse completely to comply with these requests, by arguing that the situation is different in Europe (high inflation, reasonable growth, no credit squeeze).

Forex markets in March were shaped by a dualistic world view: with a robust European economy and the ECB flying the flag for price stability on the one hand, and the Fed throwing all caution regarding price stability to the wind in order to rescue the banking system and support growth on the other. In this global scenario, the dollar fell to new lows. In our opinion, this dualism is likely to subside soon. In the last few days, the eurozone growth outlook has clouded over slightly. The same applies to Japan, where a clear indication has been given by the fact that the Tankan has deteriorated significantly. This trend will continue. The discussions in the run-up to the spring meeting of the IMF and the World Bank will highlight common risks within the global economy. In this environment, we expect the dollar to be firm for the most part.

Stephan Rieke +49 69 718-4114

Economics Department
+49 69 718-3642
[email protected]
Foreign Exchange Trading
[email protected]
Jörg Isselmann
+49 69 718-2695
Matthias Grabbe / Klaus Näfken
+49 69 718-2688


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