Friday July 8, 2005 - 16:24:27 GMT
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Forex: FX Briefing July 8, 2005Highlights
- BoE and ECB leave key interest rates unchanged
- Cable remains under pressure from interest rate cut speculation
- Greenspan testimony on the horizon
Terrorist attacks in London rattle financial markets
The terrorist attacks in London City jolted the markets. At the beginning of the week, the European currency dropped to 1.1886, the lowest it has been since May of 2004. As it became clear on Thursday that the explosions were an act of terrorism, EUR-USD shot up to almost 1.2050, but later fell back to its pre-attack level. Many other currency pairs made similar strong movements. The dollar temporarily lost a lot of ground against the yen due to terrorism fears, but then rose again to over JPY120. Apparently, market participants had looked to the attacks in Madrid on March 11, 2004 for parallels when market turmoil proved to be temporary too.
Because of the continued speculation about an interest rate cut, the British currency was unable to recover this week from last week’s drop. Even the fact that London was unexpectedly chosen to host the Olympic Games in 2012 on the day before the attacks did not help. Cable lost further ground after the London attacks. The British currency stabilized after the Bank of England decided on the same day to leave interest rates unchanged at 4.75%. However, many observers think that the BoE might take them down as early as at its next meeting. The members of the Monetary Policy Committee are likely to come to the conclusion that the interest rate hike cycle has fulfilled its goal of dampening inflationary risks connected to the real estate boom: Economic data has been persistently weak, and it will probably deteriorate further after the terrorist attacks.
Moreover real estate price increases have slowed down drastically. The upcoming meeting would be a good opportunity for such a step because the new inflation report will be available by then.
As expected, the European Central Bank also kept interest rates unchanged at its meeting. During the press conference, President Trichet took great pains not to express any bias in one direction or the other. We think the ECB will stick with its wait-and-see attitude until the beginning of September, when the Council will discuss the new staff projections in depth. Unless the euroarea economy has significantly deteriorated by then, we think that key interest rates will remain unchanged. Mr Trichet once again pointed out at the press conference that the high monetary growth constitutes an upward risk to price stability.
It is also notable that the bond markets have scaled down their interest rate cut expectations after money supply figures were very high in June and most of the economic data for the euro area was somewhat better.
Today’s US labour market data will probably determine in which direction the forex market will go next week. If the figures support the Fed’s view of a lasting labour market improvement, the dollar is likely to get another boost. We do not expect next week’s US trade balance figures to burden the greenback much since we do not see a further deterioration given that import prices dropped in May and that export development continued to be favourable.
At the end of next week the NY Empire is due, which will give us the first indications as to whether the economy continued to do well in July. Sustained high US growth would dampen the hopes that Fed chairman Alan Greenspan might announce a break in the Fed’s interest rate hike cycle at his semi-annual testimony before Congress the week after next.
Uwe Angenendt +49 69 718-3648
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Matthias Grabbe / Klaus Näfken
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