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Forex: Pound Strengthens on Stronger House Price Data

DailyFX Forex Fundamentals 02-21-05

By Kathy Lien, Chief Strategist of

· Fed Pianalto Says “Low Correlation Between PPI and CPI”
· Inflation Growth in the Eurozone Beginning to Slow
· Pound Strengthens on Stronger House Price Data


With the US markets closed for President Day, there was barely any movement in the majors that is worth noting. On a day with little data, the euro did strength against the US dollar at the onset of the European open following a sharp rise in Belgian consumer confidence. Higher oil prices in London due to colder weather in Europe and the US also contributed to a mild dollar weakness. With Germany reporting a fall in consumer prices late last week for the month of January and Italy confirming a similar trend of prices this morning, we see justification for ECB Wellink’s claim that there is no immediate “threat for inflation” and that inflation “expectations are well contained.” Wellink is typically seen as one of the most hawkish members of the ECB board and with even him claiming that rates will remain unchanged for some time, means that the ECB will continue to keep rates at 2 percent for the foreseeable future. French consumer prices due for release tomorrow are also expected to edge lower. The central bank has not made any changes to interest rates since June 2003. The major pieces of data expected from the Eurozone this week are going to be German business confidence (IFO) and French unemployment data. Yet none of these reports will change the immediate outlook for the Eurozone. Growth remains weak with Germany and Italy both reporting negative growth in the fourth quarter; so don’t expect Eurozone data to provide any optimism for the euro.


The US dollar remains unchanged on this week’s first day of trading. When the markets revert back to normal trading conditions tomorrow, the first key piece of data that the market will be focusing on is consumer prices due on Wednesday. Federal Reserve Pianalto echoed the comments made by Greenspan last week. She said that there is no immediate threat of inflation despite last week’s surge in producer prices. She said that, “there is not a lot of correlation between PPI and CPI.” In fact, according to our analysis, the correlation between PPI and CPI has fallen from 85% in 2003 to 62% in 2004. Although producers are seeing higher costs for raw materials crimp margins, consumers have remained relatively shielded from higher costs thus far. Taking a step back, we continue to believe that the dollar’s fate for the time being is tied to interest rates. Without a doubt the Fed will be delivering at least another 75bp of tightening, which will keep the dollar afloat and prevent the euro from going anywhere near its previous high anytime soon. However, once late summer, early fall rolls around, talk of an end to the Fed’s tightening cycle will begin to sweep over the market. This will coincide with the beginnings of speculation surrounding Greenspan’s replacement. All of which, would be bearish for the US dollar and could be trigger a renewed sell-off in the Greenback.


The British pound edged higher on fresh evidence of house price inflation in the UK. The Rightmove house price data reported the fastest acceleration in house prices since June. It seems that January was a particularly good month for the housing market. Prices rose 2.3% from January 8th to February 12th. This follows an earlier reported improvement in the RICS house price balance. This will make Bank of England minutes from the February monetary policy meeting a particularly interesting read. Traders will be scouring the report for hints of whether the resiliency of the housing market is any cause for concern for the central bank and whether it warrants a consideration of higher rates. Yet, it becomes increasingly clear that there is no one-way directional bias to UK economic data. This will make it difficult for the Bank of England to make any significant changes to monetary policy. With a murky outlook for the UK economy, it is difficult for any central bank to be particularly proactive.


There were no major movements in dollar yen despite weaker convenience store sales. With the latest GDP report from Japan indicating that consumers cut spending significantly in the fourth quarter, it comes as no surprise that sales at Japanese convenience stores fell for sixth consecutive month. Although Japan reported their fourth recession in 12 years last week, many economists remain optimistic and note that even though Japan entered a technical recession, the country is still experiencing its strongest growth in 8 years. GDP is expected to grow by 2.6% in 2004. The current account data reported 2 weeks ago point to recovering exports and increasing profitability, which are all signs for a stronger rebound in the first half. Yet, without a doubt, the Japanese economy has lost momentum. It remains to be seen though whether this is a temporary setback or a deeper slowdown.


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