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Wednesday April 20, 2005 - 21:11:08 GMT

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Forex: Dollar Slides Despite Rising Inflation

DailyFX Fundamentals 04-20-05

By Kathy Lien, Chief Strategist of

· Dollar Slides Despite Rising Inflation
· Euro Rallies On Surprising Decline In Oil Inventories
· Pound Holds Steady Amidst Mixed Housing Market Indicators


Traders playing the EURUSD definitely faced a rollercoaster ride today. The pair completely reversed its US CPI induced losses to rally for the fourth consecutive trading day. Even though US inflation is on the rise, there is still a concern that the US economy may have hit a soft patch. The euro reversed on news of a surprising decline in oil and gasoline stocks. At this point, it seems like things are really shaping up for a repeat of the mid-2004 slowdown. Rising oil prices, disappointments in corporate profitability, weak payroll growth and contracting retail sales have all made this a viable concern. As a result, although inflation data warrants continued rate hikes by the Federal Reserve, it does little to sway the central bank to deliver a more aggressive dose of tightening on May 3rd. There is also talk of strong Asian interest in tomorrow’s French bond auctions. Although we remain convinced that reserve diversification is inevitable, new problems surfacing in the Eurozone cannot be ignored. Italian Prime Minister Berlusconi resigned this morning following the lack of support in the regional election. This comes in the face of the continued threat of a French no-vote for the new EU constitution. With so much political uncertainty, there is good reason for the Asian nations to wait for more stability before reigniting talk of reserve diversification.


The dollar failed to hold onto its gains despite growing consumer price inflation pressures. Headline consumer prices rose by 0.6% compared to expectations for 0.5% growth. Core prices, which excludes the more volatile food and energy components rose by 0.4% versus expectations for 0.2%, which is also the strongest pace of growth since August 2004. However, to the concern of many analysts, the rise in core prices was mostly confined to higher hotel rates during the earlier Easter holiday. The Beige book echoed the warnings of higher inflation but related most of it to oil and the weaker dollar. According to most of the Districts surveyed, pricing pressures have intensified. Yet these districts also reported concern about the impact of rising energy costs on consumer demand. What this boils down to is that the Fed will still need to raise rates but probably for a longer period of time rather than aggressively. In previous editions of Daily Fundamentals, we have talked about how the Fed has only delivered half point hikes in environments of strong job growth and consumer spending. With both of these lacking for the time being, the Fed will probably shy away from taking the risk of delivering a more aggressive rate hike. US consumers are still feeling very battered by the surge in oil prices and we continue to believe that global growth at this point is dependent on oil. If energy prices continued to rise, it is another detrimental tax on consumers that the Fed has to consider. The opposite is also true, if oil prices continue to pullback, consumers may once again feel liberal about spending, which will give the Fed ample flexibility to tighten as needed.


The British pound rallied for the fourth consecutive day on little new developments. The latest housing market indicator suggests that the real estate market may have stabilized. Mortgage approvals increased to GBP4.5 billion in March, up from GBP3.5 billion. Over this past 3 days alone, we have received three conflicting housing market releases, which highlights the difficulty that the Bank of England must be facing when trying to figure out exactly where the trend of house prices are headed. Property website Rightmove said that house prices in England rose to a record high in April while in complete contrast, the Royal Institute of Chartered Surveyors reported that house prices fell at a faster pace. Meanwhile in the release of the BoE minutes from the April meeting, the vote remained unchanged with 7 members voting in favor of leaving rates at 4.75% and 2 members voting in favor of a rate hike. Although the central bank noted that the risk of inflation is still to the downside, their meeting came before yesterday’s blockbuster inflation report.


The Japanese yen inched higher against the dollar, continuing this week’s trend, as investors await industry growth figures to be released tomorrow. On average, analysts expect a contraction of 1.4%. This afternoon’s convenience store sales figure indicates same store sales continued their decline in March, falling another 1.4% versus the previous year. Convenience store data often coincides with retail sales numbers, which will be released on April 27th. Last night’s Chinese GDP figures put first quarter growth at 9.5%, suggesting China may be pressured to raise interest rates yet again to cool their overheated economy. Japan thrives from Chinese growth as China is Japan’s top export destination, so any attempts from Beijing to slow the Chinese economy would likely result in yen-selling pressure. After three weekends of successive demonstrations against Japan, Chinese foreign minister Zhaoxing Li, in an attempt to slow protests, told demonstrators that the government was capable of dealing with Sino-Japanese relationship. Taming these protests will likely ease fears that Chinese consumer boycotts will hurt Japanese export growth.


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