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Tuesday April 19, 2005 - 21:45:50 GMT

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Forex: CPI – One Last Chance For The Dollar

DailyFX Fundamentals 04-19-05

By Kathy Lien, Chief Strategist of

· CPI – One Last Chance For The Dollar
· British Pound Is This Week’s Shining Star
· Sharp Decline In Outlook For German and Eurozone Economies


The euro continued to extend its rally as US inflation data failed to deliver the blockbuster numbers that the dollar needed to regain its hold over the single currency. We will have to wait for tomorrow’s US consumer price index to make a more finalized opinion, but from the way things look right now, if core CPI also surprises to the downside, there is growing likelihood that the Federal Reserve may keep raising rates at a “measured” pace. By now, the market has completely priced in rate hikes in quarter point clips for the remainder of the year, to the disappointment of dollar bulls. Meanwhile, across the Atlantic, both the German and Eurozone ZEW surveys came in sharply below expectations. With weak domestic growth, high oil prices, uncertainty surrounding the approval of the new constitution, it is not surprising that sentiment within the Eurozone is just as weak. Growth disappointments have essentially become the norm in Europe by now, which explains the euro’s ability to reverse its earlier losses after the release of disappointing US economic data. Italian Treasury Official Lorenzo Bini Smaghi who is slated for the vacant seat on the ECB board confirmed our belief that a no vote by the French on the EU constitution will be negative for the euro. He warned that a rejection by the French will significantly hurt the relations among Eurozone nations and could possibly induce a strong slowdown in growth. Today’s election of a new Pope has had a minimal impact on the currency markets.


The dollar sold off for the third consecutive trading day on weaker core producer prices and housing starts. Although energy prices drove headline producer prices higher during the month of March, a smaller than expected rise in producer prices excluding food and energy eased concerns that inflation may be accelerating aggressively. Housing starts also experienced the sharpest fall since January 1991, declining by 17.6% to 1.837 million. The latest string of housing market data suggests that home builders and customers are finally feeling the pain of higher interest rates. However, it is not surprising to see such a sharp decline since February housing starts were the highest in 21 years. Overall, the housing market is still fairly strong and one set of data is not enough to indicate that the housing market has peaked. 2.063 million new homes were being constructed over the first three months of this year. If the pace continues, this year could be the strongest year for the housing market since 1972.


The British Pound has been this week’s shining star. The currency has rallied 300 pips against the US dollar and is now headed back towards its pre-breakdown highs in March. Despite the deterioration in the RICS house price balance from a downwardly revised -34 to –37, pound bulls have latched onto the stronger inflation numbers. EU harmonized CPI surged 1.9% y/y in March to the highest level in 7 years. This is just shy of the Bank of England’s 2% inflation target, so it certainly bolsters expectations for another rate hike sooner rather than later. In fact, after changing the inflation index last year, this is the closest that we have come to the BoE’s target. This makes tomorrow’s Bank of England minutes from the April monetary policy meeting even more interesting. In March, two members of the monetary policy committee voted in favor of a rate hike. The market will be looking to see if even more members joined the rate hike bandwagon in April.


The Japanese yen continues to advance against the US dollar on mixed but slightly more positive economic data. This morning’s business conditions indices were revised from the previous figures of 20% and 16.7% for the leading and coincident indices, respectively. The final numbers for February are now 18.2% and 30% with a small step down in the outlook regarding the future of the business cycle, but a large positive move in the gauge measuring current conditions. Machine tool orders also showed growth today as they increased 17.1% on an annual basis in March while the previous month saw a year-on-year change of 16.7%. The caveat is that although it is good that this is a continuation of over 2 years of growth, it is still slowing. In other economic news today, the new chairman of the Japanese Bankers Association, Terunobu Maeda, made a statement that he expects deflation to plague Japan for another year or two. At the same time, interest rates will be kept at zero until prices move higher. The next release of the core consumer price index is due out on April 28th in Tokyo and is expected to show a mere 0.1% annual increase.


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