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FX Briefing - Emerging markets: Central banks are becoming more cautious

FX Briefing 30 July 2010


Growth concerns weigh on dollar

Beige Book sees modest increase in economic activity

Central banks in emerging markets scale down rate hike plans


Emerging markets: Central banks are becoming more cautious

This week, EUR-USD firmed again somewhat to 1.30, even touching 1.31 briefly. The euro also rose slightly against most non-European currencies. The main reason for the movement was the diverging economic climate: both the macro data for the euro area and corporate quarterly earnings made a positive impression, especially against the gloomy backdrop of the sovereign debt crisis. The US indicators, on the other hand, underline the impression that growth has slowed down. Given the mediocre corporate results, the US equity market tended to move sideways.


Not all the US economic data painted the same picture, however: new home sales rose somewhat in June, after having plummeted the previous month, and the Case Shiller house price index showed a continuous upward trend. In contrast, the Conference Board’s survey revealed a sharp decline in consumer confidence; particularly the assessment for the coming months had deteriorated significantly. Furthermore, durable goods orders remained weak, at least the overall total. Here, things look slightly brighter if defence and civilian aircraft orders are excluded, as orders for other goods, particularly capital goods, are still trending upwards.


Market participants’ expectations or misgivings about important economic data due to be published in the next few days are also likely to be influencing their view of the economy, however. The majority are sceptical, even though the forecasts, particularly for Q2 GDP, the ISM data and the labour market, are not pointing to a collapse. At 54.5, for instance, the consensus forecast for the ISM manufacturing index suggests fairly widespread expansion; this figure is even considerably higher than the average during the economic boom from 2005 to the middle of 2007.


The widely predicted decline in payrolls is primarily due to temporary Census-related hiring coming to an end. This will probably have cost nearly 150,000 jobs in July (and presumably 200,000 more in the following two months). In contrast, employment in the private sector is likely to have risen by about 100,000. That is not a lot, compared with 2005 to 2007. But in earlier upswings, it has also taken about two years for job growth to gain momentum.


The Fed remains sceptical. The Beige Book shows a modest increase in activity – on balance, but not across the board. On the basis of this, the FOMC statement of 9 August is not likely to be more positive than the one in June. The president of the St Louis Fed, James Bullard, remarked that the US economy was closer than ever before to a Japanese-style outcome. He said that, should the economy weaken further, the central bank should implement additional quantitative easing measures such as purchases of Treasuries.


Emerging markets: more dovish stance

In the past months, an increasing number of central banks from emerging markets as well as commodity-exporting industrialised countries such as Canada, Norway, Australia and New Zealand, had begun to tighten monetary policy.


Now, however, even these countries seem to be backtracking again. This week, Brazil’s central bank only raised the SELIC rate by 50 bp to 10.75% instead of the widely expected 75 bp. The central bank stated that economic growth had cooled down to rates which were more in line with potential growth.


Similar signs emerged from China, in connection with discussions with the International Monetary Fund. Chinese officials had apparently said that fiscal consolidation in the US, Europe and Japan could have a long-lasting negative effect on growth in China. Furthermore, as the inflation outlook had improved, there was less need for higher nominal interest rates. The Monetary Fund is expecting inflation in China to decline in the second half of the year.


The Turkish central bank is exercising more caution too. In April, it had envisaged starting to raise interest rates in the fourth quarter. Given the downward revision of the inflation forecast, it was announced this week that interest rates would remain unchanged at 7% for the time being; they could be raised moderately in 2011.


After Australia and Canada had worded their interest rate hike intentions more cautiously a few weeks ago, the Reserve Bank of New Zealand followed suit this week. It raised interest rates by 25 bp to 3%, but announced at the same time that the pace and extent of future rate hikes would be more moderate than projected in June. RBNZ governor Alan Bollard said that the growth outlook had softened, and commodity prices had moderated, while the NZD was relatively strong.


India’s central bank, which also held discussions this week, was the only exception. It raised the reverse repo rate by 50 bp to 4.5%, which was more than expected, and the repo rate by 25 bp to 5.75%. However, India is a monetary policy exception, as given an inflation rate of over 14%, the interest rate level is extremely low, despite rate hikes in the last few months.


We are expecting central bankers in the emerging markets to exercise extreme caution as far as raising interest rates is concerned, while the US economy remains weak. This reticence is also aimed at limiting unwanted capital inflows and avoiding an appreciation of local currencies against the dollar, which would place an additional burden on their export activities. If our assumption is correct, and EUR-USD succeeds in climbing somewhat in the medium term, the euro is also likely to remain firm against the commodity and emerging market currencies.

Stephan Rieke +49 69 718-4114



Economics Department

+49 69 718-3642

[email protected]

Foreign Exchange Trading

[email protected]

Matthias Klein

+49 69 718-2175

Matthias Grabbe / Klaus Näfken

+49 69 718-2146 / -2683


This report has been prepared by BHF-BANK Aktiengesellschaft on behalf of itself and its affiliated companies (together "BHFBANK 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.


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