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Forex: FX Briefing June 24, 2005
Oil price hits new all-time high of $60/b, economic worries accumulate
Signals from Sweden and Great Britain fuel ECB interest rate speculation
Fed maintains course of interest rate hikes
Interest rate speculation continues to put pressure on euro
EUR-USD’s short spurt, during which it rose close to USD1.23 at the end of last week, only lasted until Monday. The interest rate cut speculation for the euro was rekindled by a Reuters report, which claimed that the ECB – according to unidentified sources close to the Council – might consider cutting interest rates if the economic development remains unfavourable. The next day, it was fuelled further by the big Swedish interest rate cut from 2% to 1.5%. And then came the minutes from the Bank of England’s Council meeting, which said that two of the Council’s nine members had already voted in favour of an interest rate cut at the beginning of June. Thus it appears that a turnaround in interest rates is on the British central bankers’ minds, too, even though Governor King has tried to play this down and emphasized the continued existence of upside risks.
These reports caused EUR-USD to fall gradually to a low of USD1.1981. The fact that the latest economic data from the EMU was mixed to friendly did not seem to help. Eurostat, for instance, reported a strong increase in new orders in the euro area, in contrast to weak the order data from Germany and France. In addition, the ZEW indicator and Belgian business confidence have improved in June, and both are considered to be leading indicators for the ifo business climate index. On the consumer side, however, there have been some signs of weakness: French consumer spending declined in May, Italian retail sales were down in April and consumer confidence data for Italy and the Netherlands was weaker.
The signals which really influenced expectations did not come from the economic indicators, but rather from the oil price development. While quotations had averaged about $50/b in May, the WTI price has been flirting with the $60 mark since the beginning of the week and has been temporarily touching it yesterday and today. There are concerns that the latest jump in the oil price, in combination with the weaker euro, might raise European energy consumers’ oil bills, indirectly dampening demand for domestic goods and services. Given that firms have little leeway to pass price increases on to consumers, market participants have written off the direct impact on inflation from higher energy prices as a temporary effect.
FOMC: Interest rate hikes not over yet
While the markets were focused on the euro area this week, next week they will probably turn their attention back to the US. Even though a numberof important indicators are due (including personal income and spending, consumer confidence and the PMIs from Chicago and the ISM), the FOMC meeting on Wednesday and Thursday will probably take centre stage.
After several FOMC members recently hinted that the gradual interest rate hikes are to continue for now, market participants are unanimously expecting the Fed to hike the fed funds rate by 25 bp to 3.25% on Thursday. That’s the easy part.
However, when it comes to the question of whether or to what extent the Fed is going to reword its statement, market participants have different views. Usually, the two-day meetings are used to evaluate the forecasts and to readjust monetary policy. This is also the preparation for Alan Greenspan’s biannual report to Congress – which is to take place in mid-July. Therefore this would be a good time to declare the end of this interest rate hike cycle.
However, we remain sceptical about whether the Fed intends to do so. Growth appears to have slowed down somewhat in the second quarter, but at around 3% it is still strong. At 5.1%, the unemployment rate is low and employment is picking up continuously. For the past several weeks now, the Fed has been moreover referring to bubbles in local housing markets. Thus we only expect the Fed to make minor adjustments to its statement which accompanies the interest rate decision. In particular, it will probably continue to describe monetary policy as accommodative as well as include the phrase that policy accommodation can be removed at a pace that is likely to be measured.
Whereas this week the increasing speculation about possible ECB interest cuts put pressure on the euro, next week the Fed’s interest rate hike intentions will probably be in the foreground. Both fuel speculation about a further widening of the interest rate spread.
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Stephan Rieke +49 69 718-4114
+49 69 718-3642
Foreign Exchange Trading
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Matthias Grabbe / Klaus Näfken
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