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Wednesday May 18, 2005 - 21:38:01 GMT
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Forex: Hong Kong and South Korea Pave The Way For Chinese Revaluation

DailyFX Fundamentals 05-18-05

By Kathy Lien, Chief Strategist of www.dailyfx.com

· Hong Kong and South Korea Pave The Way For Chinese Revaluation
· Dollar Slides On Benign Core Consumer Price Inflation
· UK Economic Data Continues To Deteriorate

US Dollar

Today’s much-anticipated consumer price inflation data let us in on one key thing – which is that producers have had some success passing over the higher energy prices to consumers, but that was it. Consumer prices excluding food and energy remained flat since March, which compares to the 0.2% growth in core producer prices for the same period. This is the first time since November 2003 that inflation failed to increase. The annualized pace of core inflation growth also dipped lower for the second consecutive month. Given that core consumer prices is one of the Federal Reserve’s favorite barometers for inflation, the latest releases adds to the mix of contradictory economic data that we have seen over the past few weeks. How much longer the Federal Reserve will raise rates still remains a big question in the markets and this answer alone will hold the fate for the US dollar in the months to come. The benign core inflation data takes a 50bp rate hike completely off the table. Even though we never believed that a half point was a possibility, some extreme optimists circulated the rumor following the most recent strong non-farm payrolls report. With inflation tamed for the time being and the Philly Fed survey being the only notable US economic release left on the calendar, the US dollar’s extensive rally should continue to show signs of exhaustion.

Euro

Like yesterday, today has been a very quiet day in terms of Eurozone economic data. Tomorrow should bring some minor excitement with the German producer prices, French current account balance, Eurozone consumer prices and industrial production slated for release. Inflation in the region as a whole is expected to subside, with consumer prices falling from 0.7% to 0.4%. Meanwhile industrial production is expected to contract for the second consecutive month. The decline was largely fostered by substantial falls in production in some of Europe’s largest economies. Germany, Italy and France saw decreases of 0.8 percent, 0.6 percent and 0.5 percent respectively. The detrimental effects of high crude oil prices have largely caused the fall in production. With heating, transportation and energy costs at high levels in March, the prices of inputs have accelerated dramatically, hurting industry and manufacturing. This has also translated into a deteriorating employment atmosphere, with the Euro-Zone unemployment rate hitting a seven-month high. The rising unemployment and eroding sentiment about the future of the economy has made it difficult for businesses to pass increasing costs of production to consumers, further hindering production.

British Pound

After eight solid sessions of consecutive losses in the British pound, the currency finally experiences a day of positive gains. Yet it is too early to get enthusiastic especially since today’s economic all suggested further deterioration in the UK economy. First taking a look at the labor market, the number of unemployed people rose by 8,100, which is three times more than the market had anticipated. Wage growth also slowed from 4.7% to 4.6% versus expectations for acceleration to 4.8%. The real disappointment though came in from the Bank of England’s minutes for the May 6 and 9 monetary policy meeting. According to the report, the vote was 8 to 1 for leaving rates unchanged compared to 7 to 2 back in March. BoE Deputy Governor large was left as the only member of the monetary policy committee favoring a rate hike. The central bank remained concerned about weak consumer spending and the still-lingering risks of a possible up-tick in inflation.

Japanese Yen

The dollar gave back yesterday’s gains against the Japanese yen following the Hong Kong Monetary Authority’s announcement of their plans to widen the USDHKD trading band to HK$7.75 – HK$7.85 from the 20 year old fixed peg of $7.80. This would allow for a half of a percent of appreciation in the Hong Kong dollar, which they said was done to bring HK interest rates more in line with US interest rates. The problem in HK is that speculative money has flooded into the country as a measure of betting on Chinese revaluation. As a result, the cash balance of the local banking system has surged, forcing HK interest rates lower in face of higher US interest rates. The appreciation is nominal but symbolically important. It has also fueled massive speculation that this may be a preliminary step to China’s revaluation. The Hong Kong government of course has denied that this is in anyway tied to China’s intentions. Meanwhile, South Korea also announced that they do not plan on accumulating any more foreign reserves and will not intervene any further in the foreign exchange markets because they believe that they have “sufficient reserves to secure” their “sovereign credibility.” It appears that the Asian nations are paving the way for China’s revaluation, allowing them to be perceived as the last to revalue because revaluation is becoming a trend for the region rather than appearing as if they are succumbing to international pressure.

 

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