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Friday November 12, 2004 - 22:26:19 GMT -

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Forex: Euro Strengthens As ECB Intervention Unlikely

DailyFX Forex Fudamentals 11-12-04

By Kathy Lien, Chief Strategist of

· Euro Strengthens As ECB Intervention Unlikely
· Dollar Weakens Despite Stronger Retail Sales Ex-Autos
· Weaker GDP Growth In Europe and Japan


The euro rallied for the second consecutive day as it attempts to take another stab at the psychologically important 1.30 level. This is quite a bold move for euro bulls ahead of Monday’s meeting of EU finance ministers. Verbal intervention in the euro has picked up significantly over the past week and the ECB has warned the markets that recent volatility has been pronounced enough for ECB officials to congregate and discuss whether additional action is needed. However, we continue to believe that the central bank will not elect to use physical intervention. With inflation currently above the central bank’s 2% target, the strong euro helps to foot some of the oil bill and bring inflation back in line with the ECB’s target. Also, even though ECB officials are currently warning about brutal moves and excess volatility, the current level of one month implied volatility is no where near the level of volatility that prompted the ECB to intervene back in September 2000. Back then one month implied volatility was approximately 17%, which compares to the current average volatility this past week of approximately 10.00%. At the time, the ECB persuaded the central banks of the US, Japan, England and Canada to aid them in intervening in the euro to stop it from sliding. Between Jan 2000 and Oct 2000, the value of the euro fell 21% against the dollar, forcing the ECB to step into the markets and buy euros. The ECB has to date never sold euros as apart of intervention efforts. German Chancellor Schroeder attempted to curb the currency’s rise by saying that he is now “concerned” with the EURUSD rate. Meanwhile, Eurozone Q3 GDP fell short of expectations, as it was dragged lower by weaker German and French growth.


The dollar weakened against all of the majors despite stronger than expected US retail sales and higher consumer confidence. Retail sales increased 0.2% m/m and 0.9% m/m less autos. Although the pace of growth in October pales in comparison to the headline number of 1.5% in September, growth in the less volatile retail sales less autos component increased from an upwardly revised 0.8% to 0.9%. This marks the fourth consecutive month of increased consumer spending. Consumer confidence also picked up in the month of November on the back of stronger job growth last month and receding oil prices. However not all news was good news, business inventories only increased 0.1% in September, indicating that businesses have been only been cautiously rebuilding inventories. The minutes from the September 21 FOMC meeting gave no new insight on monetary policy. The Fed nodded to the improving expansion but warned about the widening gap between the current account and trade deficit versus investment flows. Next week we are expecting the Treasury International Capital Flow data for the month of September. A continued decline in foreign investment into the US would be a serious cause for concern for the greenback and could be what the euro is looking for to crack the 1.30 level against the dollar.


Despite this week’s gyrating price action, the British pound has essentially remained range bound between 1.84 and 1.86. The currency’s move to the top of the range today is primarily a reflection of dollar weakness and euro strength. As for next week, keep your eyes on few pieces of key data. CPI data is expected to show signs of rising inflation as the labor market retains tightness with unemployment expected to stay unchanged for October. This mixed with consumer spending that is feeling the pinch from falling house prices is expected to create a concoction of reduced retail sales. We’ve already seen a sign of this from this Monday’s paltry BRC retail sales increase of 0.5% for October, down from 2.0% in September.


In spite of yesterday’s lower than expected Japanese GDP release, the yen managed to strengthen against the dollar today. For the most part, expectations for disappointing growth data was already priced into the markets with investors preparing for signs of contraction after the weak September machinery order number on Thursday. When GDP came in at 0.1% real growth, much lower than the median forecast of 0.5%, the mere fact that it was positive gave the currency markets a reason to end Wednesday’s slide. Also, September’s final Japanese Industrial Production index was revised up 0.3% from the preliminary figure of 0.1%. The main contributor for the yen’s strength, however, may have been the hopeful comments from BoJ Governor Fukui. He identified himself as a “firm believer in the potential of the Japanese economy” and encouraged the market to look to a brighter future. In addition, the speculation on a yuan revaluation continues to offer strength for the yen. Japan, as a net exporter to China, will experience greater demand for its products while the dollar will be hurt. Thereby, its effects on the USDJPY pair will be magnified. Yet, with the yen at 6-month lows and approaching the pain threshold of 105, we could see some BoJ intervention. Watanabe, the Vice Finance Minister for International Affairs, has stated that they are monitoring the USDJPY “seriously” and that “if the pace of the fall is not justified by fundamentals we will take action."


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