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Thursday April 7, 2005 - 22:00:33 GMT

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Forex: Euro Slides As ECB Hints That Any Rate Hikes Will Be Delayed

DailyFX Fundamentals 04-07-05

By Kathy Lien, Chief Strategist of

∑ Euro Slides As ECB Hints That Any Rate Hikes Will Be Delayed
∑ Dollar Rallies On Tumbling Oil Prices
∑ Pound Retreats As UK Economy Shows Signs Of Weakness

Lower oil prices and a hint of dovish sentiment in ECB Trichetís comments have given the euro reason to reverse course. This morning in our FXCM SSI report, we said that positioning was nearly 1 for 1 with a tiny bias to the short side. However, the bias was so miniscule that the only information we can draw from it is that the market is divided on where the euro will be headed next. More recent data indicates that bulls have once again reentered the market, trying to pick a bottom in the euro. Following the ECBís decision to keep interest rates unchanged, Trichet acknowledged that recent data has been disappointing and that growth has only been moderate at best. Trichet suggests that acceleration in Eurozone growth may not come until the latter part of this year and although he said outright that the central bank would not be lowering rates, he also indicated that any rate hikes might also be delayed. From the ECBís perspective, this is pretty dovish, especially since his statement focused more on growth than the inflationary effects of higher oil prices. Confirming the regionís weakness in growth was the sharp fall in German Industrial during the month of February. In fact, the contraction was the largest in 2 years as oil prices exacerbated already weak domestic demand while at the same time increasing input costs for companies. The undisputable weakness in the Eurozone should keep the ECBís hands tied for at least another quarter.

The only factor moving the dollar today was oil prices. This comes in contrast to a harsh warning by the IMF that the world may need to get use to high oil prices for the next 20 years if a permanent oil shock develops. The group predicts that increasing demand from emerging countries such as China and limited new supply will force oil prices to remain high. The US continues to call for OPEC to increase production, but many OPEC members themselves claim that they may be near capacity. There is a very interesting article by John Mauldin on how $100 oil may just be the solution. He claims that if oil reaches $100, gasoline prices could hit $4 a gallon which would mean that it could cost between $80-$100 to fill up a tank of gas. This would force many drivers to cut back car usage and for prospective car owners to consider hybrids. Having just come back from speaking at a seminar in LA, I can attest to the over usage of automobiles. Although LA traffic is horrid, it tends to be a smooth ride on the car pool lanes, which actually only requires 2 or people. With gridlock traffic on the regular free-way, you can imagine how many people are the only ones in their automobiles. Extraordinary high oil prices will force people to carpool more or look into other sources of fuel / energy, which could eventually will lead to a resumption in the downward trend of demand.

The BoE decided at this monthís meeting to leave rates unchanged at 4.75%, which was in line with market expectations. It appears that the weak consumer spending bug that the English caught from mainland Europe is lasting a bit longer than desired. The bankís governor Mervyn King cited this as the major downside risk present in inflation and growth forecasts. With this decision being the last before the May 5th general election, it could put a slightly sour note in the economic growth tune that Blair has been singing. On the other hand, there may be a few dissenting opinions coming from Andrew Large and Paul Tucker, who both voted for increases last month after recognizing that the low unemployment rate may be brewing into higher wages, which would put upward pressure on prices. Related to the sluggish consumer demand, production data for February came in weaker than expected early this morning. Overall industrial production declined 0.4% from the previous month while manufacturing slowed by 0.5%. This comes after economists surveyed by Bloomberg expected both to increase slightly, by 0.2% and 0.1%, respectively. With data like this and some analysts forecasting that consumer demand not picking up until the summer, the previously expected rate hike in May, might not show up until later in the year.

There seemed to be some hope for the yen today as the pair dipped down to 108.10 before coming back up and completely erasing any gains by the end of the day. The problem with having oil price reductions working in the yenís favor is that the strength canít last since the downward movements are quite beneficial for the dollar as well. As a part of todayís monthly monetary policy report, which revealed a decision to keep rates unchanged, the committee also announced a decision to slightly shrink current deposits at the bank to a level within the range of •30-35 trillion. This isnít too significant of a change and BoJ Governor Fukui stressed that it shouldnít be regarded as a move towards monetary tightening because deflation evidently still exists. In the report on economic development, the bank also stated that consumer prices continue to decline on a year-on-year basis, domestic corporate goods prices (which will be released later today) will most likely rise based on the rise of worldwide commodity prices. The general tone of the rest of the report is mediocre at best. The bank spoke of rising exports from expansion in global economies while businesses remain ďcautiousĒ despite higher profits. Private consumption is seen as being steady due to improvements in employment and the halt of declining household income. Also released today was preliminary data on machine tool orders, which revealed a 16.7% change from a year ago, down from an increase of 26% in February.


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