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Forex: FX Briefing

FX Briefing 5 August 2005

- German industry starts second half of the year with gusto
- Economic data could boost the yen, but political uncertainty is a drag
- FOMC continues with interest rate hike policy

Growing growth optimism: Euro breaks out above the trading range
EUR-USD has left its trading range and reached the highest level since the end of May at USD1.24, when the euro had dropped 3 cents in reaction to the French population rejecting the EU constitution. The European currency also firmed against other important currencies. EURJPY, for instance, is trading at JPY138 at the close of the week, which is about 1.6% higher than last week’s closing price. The reason behind this is the continuing political uncertainty in Japan. Prime Minister Koizumi had threatened to dissolve parliament if the postal privatisation bill is not passed. The pound sterling weakened too, dropping by around 0.9% versus the euro to GBP0.695. This could be partly due to the Bank of England’s interest rate cut. However, this had been widely expected and hopes of further interest rate cuts have been dampened by the more upbeat economic data.

EMU growth in Q2: Rather moderate
The main reason for the euro’s remarkable strength is the brightening of the economic outlook for the euro area. This was reflected, for instance, in the favourable purchasing managers’ data, first for the manufacturing and then for the services sector. The upward trend was confirmed most impressively by new orders in the German manufacturing sector: Q2 orders rose by 1.9% compared to the previous quarter, and the June level implies an overhang of 2.8% for Q3. It is especially cheering that, in addition to demand from abroad, there are more and more domestic orders.

Next week the respective statistical offices will publish the first Q2 GDP estimates for the major EMU countries and the entire EMU. After the strong 1% increase qoq in the first quarter, German growth in the second quarter is likely to have been meagre. Thus EMU growth has probably fallen short of the 0.5% reached in the first quarter despite the fact that Italy and France are likely to have caught up compared to Q1. So the economic data from the EMU will not fuel optimism further for now. Having said that, the weakening in Q2 has already been incorporated in most growth forecasts. Therefore upward corrections rather than further downward revisions are to be expected, if the economy picks up in the second half.

Japan: Political uncertainty vs. economic recovery
The vote on the postal privatisation bill in the Japanese upper house of parliament has been postponed to Monday morning – presumably to gain time for further negotiations. The latest reports indicate that Prime Minister Koizumi might not get the necessary approval of the upper house for his reform, which he called one of his most important ones. Since Mr Koizumi has no chance of getting a two-thirds majority in the lower house which could overrule the upper house rejection of the bill, this is a make-or-break vote. If the bill fails, the ball will be back in Koizumi’s court: Recently, the Prime Minister said that rejecting his privatisation project would be equivalent to a vote of no confidence for his policy. Unless he wants to spend the remainder of his term of office as a lame duck, his only option is to dissolve the parliament and call early elections – which the LDP would absolutely hate after the

painful losses in the last upper house elections.

At the moment two factors are burdening the yen:
One is the political uncertainty, the other is the high and growing interest rate disadvantage compared to the US. But on the up side we have an economic recovery – similar to the situation in Europe. Q2 growth is forecast at 0.5% qoq, which would be a clear confirmation of the economy picking up after the extraordinarily strong start to the year with +1.2% qoq. The positive outlook is buoyed by the favourable development of income and the improved labour market situation, which promise solid private consumption figures for the second half of the year. The end of June Tankan already indicated favourable business expectations and a growing willingness to invest.

All in all it appears that the Japanese economy is recovering more quickly than expected a few weeks ago. The Bank of Japan moreover forecasts positive inflation rates for winter. This means that for the first time in years we have the prospect of the quantitative easing policy coming to an end, albeit not any time soon. In our opinion there are quite a few economic arguments for a stronger yen – especially since the latent appreciation trend for the renminbi is a supporting factor for all Asian currencies.

Fed lifts key interest rate further
US economic data is likely to be as good next week as it was this week. Retail sales in particular have probably jumped in July: We expect an increase of around 2% month-on-month. Even excluding cars, growth will have remained very robust at 0.7%. Other indicators to watch will be the development of Q2 productivity and unit labour costs and, at the end of the week, the trade balance figures.

The main focus, however, will be on the Open Market Committee’s interest rate decision on Tuesday evening. Given the Fed’s critical assessment of the real estate market and the labour cost and commodity price developments, there is basically no doubt that the fed funds rate will be raised by 25 basis points to 3.5%. A more or less unchanged statement will indicate further interest rate hikes. What will be interesting to see is whether the Fed mentions the marked upwards revision of the private consumption deflators, given that the PCE core deflator is its most important target indicator.
Stephan Rieke +49 69 718-4114

Economics Department
+49 69 718-3642
[email protected]
Foreign Exchange Trading
[email protected]
Jörg Isselmann
+49 69 718-2695
Matthias Grabbe / Klaus Näfken
+49 69 718-2688

This report has been prepared by BHF-BANK Aktiengesellschaft on behalf of itself and its affiliated companies (together "BHF-BANK Group") solely for the information of its clients. The information and opinions in this document are based on sources believed to be reliable and acting in good faith, but no representation or warranty, express or implied, is made by any member of the BHF-BANK Group as to their accuracy, completeness or correctness. Opinions and recommendations are given in good faith but without legal responsibility and are subject to change without notice. The information does not constitute advice or personal recommendation, for which the duty of suitability would be owed, but may facilitate your own investment decision. Moreover, you should seek your own advice as to the suitability of an investment matter mentioned herein. Investors are reminded that the price of securities and the income from them can go down as well as up and that the past performance of an investment or a market is not necessarily indicative for future results. This document is for information purposes only. Descriptions of any company or companies or their securities mentioned herein are not intended to be complete, and this document is not, and should not be construed as, an offer to sell or solicitation of any offer to buy the securities mentioned in it. BHF-BANK Group and its officers and employees may have a long or short position or engage in transactions in any of the securities mentioned in this document, or in any related securities. This publication must not be distributed in the United States.
© 2005 BHF-BANK Aktiengesellschaft
All rights reserved. Please mention source when quoting from it.


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