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FX Research - FX Briefing - ECB meeting eagerly awaited

FX Briefing 29 August 2008


·        Ifo business expectations indicate recession

·        EMU inflation rate heralds downward trend in August

·        ECB likely to place more emphasis on growth risks


ECB meeting eagerly awaited


EUR-USD moved somewhat erratically this week. On Tuesday, the euro slipped to a weekly low of 1.457 against the dollar, as weak business climate data from Germany triggered speculation about interest rate cuts. Later in the week, however, markets were taken aback by remarks from ECB representatives such as Axel Weber and Lucas Papademos, who said that talk of interest rate cuts was premature and that, due to the high inflation rates, the central bank might even need to consider further rate rises. This pushed the European single currency over 1.48 for a time. Crude oil prices rose in connection with hurricane Gustav, which probably weakened the dollar too. However, at the end of the week, at 1.472, EUR-USD is about 1 cent below last Friday’s level again, not least due to favourable EMU inflation data.


The results of the August ifo business climate were much worse than expected; business expectations, which had already fallen sharply the previousmonth, fell again more sharply than the assessment of the current situation. The deterioration in the manufacturing sector was particularly marked. There was also a further drop in sentiment in the retail trade, despite hopes that it might have stabilized somewhat due to having plummeted the previous month. All in all, expectations have plunged to their lowest level since February 1993. Thus the assessment of the current situation, which is still relatively high, could well drop significantly in the coming months; the business climate will therefore deteriorate further. The downward trend in the EMU economic sentiment, which had started in June 2007, also continued; it has now reached its lowest level since March 2003. The current data give no indication that the economic downturn is limited to the summer months and that growth will stabilize again towards the end of the year. This is what Axel Weber’s hawkish remarks were based on. The OECD composite leading indicators published at the beginning of August show the recessionary tendency prevailing in all major economies with the exception of China and Brazil. Moreover, there is little hope of consumption driving growth in the eurozone either; the detailed breakdown of the German GDP data published at the beginning of the week showed that private consumption fell in the last three quarters, despite a more favourable labour market and higher wage increases. Thus consumption has been in recession for some time.


Axel Weber is correct in his assumption that, despite weak global growth, harmonized consumer

price inflation in the eurozone will still on average remain above the ECB’s target of around 2% in 2009. But the fact that inflation rates have now peaked will have a significant impact on inflation expectations. In Germany, harmonized consumer prices dropped by 0.4% month-onmonth in August, and this was not just because of the energy price correction. The development of prices has been more favourable than expected in the eurozone too; the flash estimate for August showed that inflation fell from 4.0% to 3.8% year-on-year. As the decline in annual inflation rates will accelerate until the end of the year, and


At its meeting next week, the ECB governing council will probably emphasize the inflation risks again as at the beginning of August. Nevertheless, its risk assessment is likely to be more balanced. Given the weak economic signals, Jean-Claude Trichet will, unlike Axel Weber, avoid talking about the possible necessity of interest rate hikes. As far as the projections are concerned, we are expecting the most significant changes to be on the growth side: the central projection for 2008 GDP growth is likely to be revised down from 1.8% (as forecast in June) to 1.5%, and for 2009 from 1.5% to 1.2% or even 1.1%. On the other hand, the inflation projections for both years might only be raised by 0.1 percentage points to 3.5% and 2.5% respectively.


The Bank of England’s monetary policy committee meeting is also taking place next Thursday. At the last meeting, seven of the nine committee members voted in favour of keeping interest rates on hold, one member voted to raise them, and another to cut them. Due to the sharp economic slowdown, the Bank of England is expecting inflation to fall below the 2% target during the course of the 2-year forecast period. But fears that inflation rates could go on increasing initially could prevent an immediate interest rate step. Given the steep deterioration in UK economic data, however, we assume that the number of monetary policy committee members in favour of taking such a step will increase.


If, as we are expecting, the ECB Council expresses mounting concern about the economic

outlook, this is likely to be the most important signal for the forex markets next week. There

would then be scope for the euro to fall again, even if important US economic data due next week turn out weak for the most part: we are expecting both ISM indices to have contracted again in August, and non-farm payrolls to have fallen more sharply. This would make it clear that the acceleration in annualized growth in the second quarter to a revised 3.3% qoq was only a temporary phenomenon. The tenor of the Beige Book on economic growth and domestic demand in particular is likely to be similar.

Peter Meister +49 69 718-2600


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


<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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