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Thursday July 14, 2005 - 21:34:47 GMT

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Forex: Dollar Inflation Data Puts 4% Rates In Question

DailyFX Forex Fundamentals 07-14-05

By Kathy Lien, Chief Strategist of

· Dollar Inflation Data Puts 4% Rates In Question
· Euro Rallies As ECB Sees Higher Inflation Risk
· Pound Slides As BCC Quarterly Survey Illustrates Worsening Conditions

US Dollar

After experiencing two days of trading ranges that were close to 200 pips in the EURUSD, today was on a relative basis, rather quiet. The narrower range was actually surprising since today’s economic calendar was chock full of important data that provided a better signal of how the economy is doing and insight into what Greenspan may say at next week’s Humphrey Hawkins testimony. First off, the big surprise today was the unchanged reading in consumer prices this morning. Despite the sharp rise in oil prices, gasoline prices fell causing headline inflation to remain flat while core prices, which excludes the volatile food and energy components increased a paltry 0.1 percent during the month of June. The stronger dollar last month should have also offset some of the upside inflation pressures. It is increasingly apparent that the US inflation rate is declining gradually. This will be an interesting topic of conversation for Greenspan at next week’s testimony. Inflation pressures should be to the upside, but the data does not really confirm that. Also jobless claims increased to their highest level since May due to factory and school layoffs. Retail sales did rise, but the bulk of the increase came in the auto sector, which had higher sales as a result of the aggressive price cuts made by General Motors. As we stand, the muted reaction in the EURUSD illustrates the debate that is undergoing in the markets right now. 3.50 percent rates are certain and so is 3.75 percent – the question then turns to 4 percent rates. The latest string of data that we received today puts into doubt all of the excess optimism about 4 percent rates that we saw last week after the ISM data, which has capped further dollar gains.


The Euro held onto the 1.20 handle today thanks to some modestly positive news. Growth in the Eurozone increased 0.5 percent in the fourth quarter confirming earlier estimates. The annualized rate though was bumped up to 1.4 percent from 1.3 percent. Like the US, the focus of the day was on inflation. Six Eurozone countries reported inflation for the month of June this morning. Overall, the numbers suggest that inflation for the region as a whole should be ticking higher modestly. European Central Banker Issing laid out the ECB’s bias today when the ECB Monthly Bulletin was released. Issing expects inflation to remain above 2 percent for the remainder of the year, adding that the inflation outlook has “clearly worsened.” This implies that given the central bank’s 2 percent inflation pain threshold, means that the ECB will not be cutting rates anytime soon. If anything, the ECB’s bias would be slightly to the upside with some modest optimism in terms of growth. In the ECB Bulletin, the central bank also warned that they remained “vigilant” and ready to act on rising inflation, if needed. Though a far-fetched possibility, it still further solidifies their on-hold stance.

British Pound

Doom and gloom remained the theme in today’s market for the pound sterling as yet another reason for near term interest rate cut considerations by central bank officials arose out of the largest independent business survey in the U.K. According to the British Chambers of Commerce Quarterly Economic Survey for the second quarter, current conditions seem worrisome, as declines in manufacturing remain a detriment to the country’s expansive potential. Most notably, however, was the lowest sales report in the services sector since 1998. Adding signs to a slowdown in the U.K., the services sector, which accounts for two-thirds of the economy, reported that domestic sales fell in the quarter with a balance of domestic orders halved to a reading of nine. The report confirms recent pessimism and has been echoed by a handful of policy makers as business conditions have worsened. To make matters worse, employment expectations dipped in the month along with capital expenditures and key confidence indicators in the report. Ultimately, this may make the Bank of England’s decision on implementing a more expansionary monetary policy easier as evidence is seemingly coming from all sides now. The only question that remains now is how accommodative Governor Mervyn King and his band of monetary authorities will be in reviving the economy. According to interest rate futures traders, the answer may be quite accommodative. Implied rates on interest rate contracts maturing in December stand at 4.31 percent, suggestive of a definitive drop to 4.5 percent on short term repurchase rates.

Japanese Yen

What is going on in the land of the rising sun? With the release of today’s bankruptcy report, economists are now indefinitely casting doubt on the sustainability of the momentum seen earlier in 2005, in light of expectations for strong consumer consumption. Corporate failures soared 29.3 percent in the month on month comparison and rose 11.9 percent in the annual figure as the total monthly number rose to 794 with most increases remaining in construction and retail industries. Specifically, failures leapt 77.5 percent higher in the retail industry while surging 56 percent in construction. With additional data pointing to smaller struggling entities, it may seem that recent declines on government assistance and economic recovery may be bottoming out, raising some red flags. As a result, the burden now lies more than ever on the economy’s consumers to pull, if not drag the country into growth in the second half of the year. However, with recent dips in confidence and productivity factors, it may not be short of a miracle like task. Growth is expected to slow just below 0.5 percent for the second quarter for the Japanese economy.


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