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Friday June 27, 2008 - 15:08:45 GMT
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Forex Blog - FX Briefing - Growth concerns put dollar under pressure

FX Briefing 27 June 2008

Highlights

·        Soaring oil prices and credit crisis weigh on equity markets and dollar

·        Inflation rates in the eurozone set to hit record highs, growth outlook gloomier

Growth concerns put dollar under pressure
During the course of the week, the dollar lost ground across the board again. Towards the end
of the week, EUR-USD was around 1.5750. The
US currency did not fall all that sharply compared to the previous week, but it is now nearing the “upper limit” of the trading range over the last few months again. USD-JPY remained relatively firm, dropping to under 107. In contrast, EUR-JPY gained more ground: during the course of the week, the European currency rose to  169.46, – a new record high against the yen.

The fresh bout of depreciation was triggered by the Open Market Committee’s statement on Thursday. According to the Fed’s latest risk assessment, the balance of risks has shifted towards inflation risks, but only slightly. Furthermore, in its description of the risks, the Committee was non-committal: uncertainty about the inflation outlook had increased, but inflation was expected to moderate later this year. Consequently, the statement contained no indication of an imminent interest rate rise, apart perhaps from one single vote: Dallas Fed president Richard Fisher was in favour of raising the fed funds rate.

The Fed’s relatively dovish stance is, however, in line with market participants’ mood. Up until
recently, soaring energy and commodity prices and accelerating inflation in their wake had been regarded predominantly as a challenge for monetary policy. Thus the increase in oil prices went hand in hand with interest rates hikes. But the higher the oil price climbs, the more the growth risks come to the fore.

The price shock caused by rising energy and commodity prices together with the financial
shock emanating from the credit crisis are having a dangerous contractive impact. On the one hand, there are stricken banks, whose scope to act is limited due to asset writedowns and functional disruptions in important market sectors. The banks are passing the buck to their customers by tightening financing requirements and credit conditions for consumers and companies alike. On the other hand, there are companies and households deep in debt; because of the soaring energy and commodity prices, they are forced to cut back their costs and limit their spending.

Towards the end of the week, the oil price (WTI front contract) rose to over $141 per barrel. Several factors were responsible for this: production shortfalls in Nigeria due to strikes, the OPEC president predicting that the oil price would rise to $170/b in summer, and Libya threatening to reduce output. This price surge and a spate of negative news from the financial sector probably contributed to the slump in equity markets – during the course of the week, the Dow Jones fell by about 5%. Despite the fact that the oil price is still rising, interest rate levels and rate hike expectations have been scaled back noticeably – not just in the US, where the Fed is in “wait and see” mode, but also in the eurozone, where the central bank has already signalled that it will raise interest rates to 4.25% next week.

Inflation in the eurozone appears to have accelerated more sharply than expected in June: according to the national data available so far, inflation could have increased to at least 3.9% year on year. And if the oil price of over $140/b does not correct soon, inflation could even rise significantly over 4% in the next few months. This would be considerably higher than the ECB projection for 2008 (3.2 to 3.6%).

Partly due to rising energy and commodity prices, business and consumer polls are signaling that the economy is slowing down noticeably. The ifo institute indicates that the business climate has deteriorated significantly in June, by 2.2 points to 101.3. The drop in the manufacturing industry was particularly striking. Moreover, according to GfK, the consumer climate plummeted from 4.7 to 3.9. In the eurozone as a whole, the climate deteriorated even more markedly: the EU Commission’s indicator of economic sentiment fell by 2.7 points to 94.9, and is now nearing levels last seen in the period from 2001 to 2003.

It is practically a foregone conclusion that interest rates will be raised at the ECB Council meeting next Thursday. In view of the recent developments, the ECB will probably emphasize the inflation risks after the decision too. The hawkish tone is likely to be retained. However, the latest climate and confidence indicators provide enough ammunition for presenting the growth outlook in a slightly more critical light. Credit growth to non-financial corporations was also weaker in May for the first time. The ECB will therefore probably refrain from making any firm interest rate policy commitments.

Stephan Rieke +49 69 718-4114
Economics Department
+49 69 718-3642
volkswirtschaft@bhf-bank.com
Foreign Exchange Tradingdevisenhandel@bhf-bank.com
Jörg Isselmann
+49 69 718-2695
Matthias Grabbe / Klaus Näfken
+49 69 718-2688

<i>This report has been prepared by BHF-BANK Aktiengesellschaft on behalf of itself and its affiliated companies (together "BHF-BANK Group") solely for the information of its clients. The information and opinions in this document are based on sources believed to be reliable and acting in good faith, but no representation or warranty, express or implied, is made by any member of the BHF-BANK Group as to their accuracy, completeness or correctness. Opinions and recommendations are given in good faith but without legal responsibility and are subject to change without notice. The information does not constitute advice or personal recommendation, for which the duty of suitability would be owed, but may facilitate your own investment decision. Moreover, you should seek your own advice as to the suitability of an investment matter mentioned herein. Investors are reminded that the price of securities and the income from them can go down as well as up and that the past performance of an investment or a market is not necessarily indicative for future results. This document is for information purposes only. Descriptions of any company or companies or their securities mentioned herein are not intended to be complete, and this document is not, and should not be construed as, an offer to sell or solicitation of any offer to buy the securities mentioned in it. BHF-BANK Group and its officers and employees may have a long or short position or engage in transactions in any of the securities mentioned in this document, or in any related securities. This publication must not be distributed in the United States.

© 2007 BHF-BANK Aktiengesellschaft

All rights reserved. Please mention source when quoting from it.

 

 

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