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Friday January 16, 2009 - 16:08:00 GMT
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FX Briefing - Euro under pressure

FX Briefing 16 January 2009


·        ECB cuts to 2 %, refers to March meeting

·        S&P lowers rating for Greece, negative outlook for other EMU countries

·        Reporting season off to a disappointing start

·        ECB view that inflation risks are balanced is difficult to comprehend


Euro under pressure

During the course of the week, EUR-USD has fallen significantly. The single European currency dropped from about 1.37 at the end of last week to below 1.31 at times and was trading below 1.33 at the close of the week. In our view, there are three major factors weighing on the euro at present:

(1) The drastic deterioration of the growth outlook  in the eurozone:

 It looks as though economic output will contract even more sharply in the eurozone than in the US in 2009. Against this background, markets are assuming that further sizeable interest rate cuts will be necessary in the euro area. The reactions of policymakers, including the ECB, are regarded as being too slow and inadequate. And if policymakers do not pull out all stops, stabilisation will be delayed, and the problems will intensify.


(2) Weakness in equity markets:

Apart from the weak economic data, the start of the reporting season is currently dampening investors’ mood considerably. The earnings reports released so far have not been at all encouraging.

(3) Concern over the fiscal strength of some euro nations:

Greece’s credit rating has been downgraded, the outlook on some other EMU member states’ ratings has been put on negative, and there are rumours (officially denied) that Ireland might request the support of the International Monetary Fund. There is growing concern that some of the smaller member states, which are in a weaker economic position, might not be able to withstand the fiscal burden of the financial and economic crisis. There is considerable uncertainty in the markets about the risks stemming from the financial and property sector; one chilling example is Iceland, where the extent of the debt burden exceeded the country’s economic output by far. Moreover, the institutional uncertainties are higher than in the US for example: how much solidarity is there amongst the member states, and will the ECB be the lender of last resort?


The sustained slide of the US economy – where the rapid increase in unemployment is threatening to put consumer spending under even more pressure – is not having an impact on the dollar at the moment. This is probably partly due to the Obama factor. His inauguration stands for a fresh start, and the massive stimulus package, currently in preparation, is making the political event more significant. The $800bn package is likely to help to stabilise economic activity, at least for a while. (In the long term, however, it should be borne in mind that the correction of the US current account deficit is an essential part of the global adjustment process. Thus the dollar only has limited appreciation potential).


EMU inflation risks balanced?

The ECB has succumbed to the pressure of the data and cut interest rates by 50 basis points to signalled that there was still scope for further cuts, but that a decision was not likely to be taken until March, when the new macroeconomic projections are released.


By cutting interest rates on Thursday, the ECB acted as markets had been expecting. Over the

last few weeks, the economic indicators had deteriorated so drastically, that the December risk

assessment was no longer valid. However, the accompanying statement and ECB president Trichet’s comments betray a certain lack of direction. The ECB governing council did admit that growth risks have become evident and that inflation pressure has diminished – due to the unfavourable growth outlook. And it said that there is unmistakable evidence of downside risks to growth, despite the interest rate cut. But at the same time the governing council kept claiming that the medium-term inflation outlook corresponds with the price stability target (this had already been maintained in December) and that the risks are broadly balanced. This assessment of the risks to price stability is inconsistent: the need for revision, which the ECB sees on the growth side, implies a continuous and marked widening of the demand gap, presumably over the entire projection period until the end of 2010. This means pressure on prices, especially if there is increasing excess supply worldwide. Therefore the inflation forecast for 2010 would have to be reduced.


All the more so, since the December inflation projection was based on much higher oil prices i.e. $67 in 2009 and $77 in 2010 – at an exchange rate of 1.27. Oil market futures prices are currently about $15 lower for both years. All in all, the ECB’s December inflation projection with an average of 1.8%, is now just as invalid as the growth projection. But apparently the ECB is still loath to acknowledge downside risks to price stability, i.e. deflation risks, and to take the monetary policy consequences.


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


<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

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