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Friday August 26, 2005 - 18:35:49 GMT
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FX Briefing 26 August 2005

- Favourable opinion polls for prime minister Koizumi support the yen
- Friendly economic data and German elections strengthen the euro

September promises to be eventful

Last week’s rapid recovery of the dollar to USD 1.2150 against the euro and JPY 110.50 against the yen was followed by a slight decline.

The Japanese equity market and with it the yen initially profited substantially from the improving opinion poll results for prime minister Koizumi. Especially foreign investors seem to welcome the prospects of the LDP’s reform-minded forces winning the upper hand in the upcoming elections to the lower house. In view of the new record highs in crude oil prices, volatile equity markets and the further deterioration in Japan’s trade balance, the USD-JPY rate lost momentum for some time but closed the week moving up to around JPY 109.50 again.

EUR-USD climbed, once again exceeding USD 1.23. This was attributed mainly to the improvement in the German economy, as confirmed by the ZEW indicator of economic sentiment and, with some reservations, also by the German ifo institute’s business climate index. The disappointing levels of new orders in the US durable goods industry were another reason. Last but not least the impending elections in Germany – like those in Japan – are considered to be feeding reform expectations and hence to be a driving factor.

The end of the summer
The calm summer session will be coming to an end soon. In London, the bank holiday next Monday will mark the end of the holiday season. One week later, the US will have its Labor Day weekend which marks the end of the driving season. The short week in between these long weekends will, however, bring many important indicators and a number of major events. And there is more to come: a glance at the calendar shows that the month of September has an exceptionally tight schedule of major political events.

First of all, there will be early elections in Japan and Germany on 11 and 18 September respectively. According to the latest opinion polls, prime minister Koizumi’s position might be strengthened. It seems as if the LDP’s conservative wing, which opposes the privatisation of Japan’s postal services, is being pushed into the sidelines whilst the party’s reform-minded forces might be gaining ground. In Germany, it rather seems as if the elections will lead to a change with the Christian Democrats taking over. Both these scenarios and the expected political change they imply have been welcomed by the markets.

On 25 September, one week after the elections in Germany, Poland will elect a new parliament (and a new president in October). At the moment, the opinion polls give the lead to the two opposition parties “The Citizen’s Platform”, which wants to implement radical tax cuts, and the “Law and Justice” party. The ruling “Democratic Left Alliance” is lagging far behind. However, it is currently trying to catch up by offering a reduction in value added tax, a difficult move given the country’s budgetary situation. As regards the currency markets, it will probably be rather important whether Poland holds or deviates from its course into the EMU, be it due to fundamental reservations (as brought forward by “Law and Justice”) or due to a lack of compliance with the EMU criteria. The EU integration process will be put to another test in the Danish referendum on the EU constitution to be held on 27 September.

In terms of international affairs, there will be quite a lot of material in September, too. The Chinese president Hu Jintao will visit the US, a meeting with president Bush is planned for 7 September. Above all the US representatives are expected to seize this opportunity in order to discuss the Chinese exchange rate policy and complain about “currency dumping”. Some market participants are currently toying with the idea that China might slightly loosen the reins in its forex policy, as a gift when visiting the US. Global economic relations will come to the fore again on 24 and 25 September with the annual meeting of the World Bank and the International Monetary Fund in Washington. The meeting is expected once again to focus on current account imbalances in Asia and the US, and the effects of crude oil prices on the global economy are also very likely to be on the agenda.

As far as the latter topic is concerned, it should be noted that with the end of the driving season in the US, attention will shift from the gasoline inventories (rather low at the moment) to the (relatively ample) stocks in heating oil. The OPEC will meet on 19 September.

Finally, the central banks will also take the floor again in September. Whilst the ECB (1 Sep) and the BoJ (6/7 Sep) are currently not expected to bring any major impetus, the picture looks different for the Fed. Although it seems almost certain that the FOMC meeting of 20 September will raise the key rate to 3.75%, the flattening of the US yield curve in the last few weeks shows that the markets expect the cycle of interest rate hikes to come to an end soon. 5yr Treasury Notes are yielding no more than a good 4% at the moment, those maturing in 10 years earn 4.15%. If the FOMC meeting of 20 September maintains its current assessment of the overall economic risks, thus implicitly announcing a further interest rate hike to 4% in November, the current yields can no longer be justified.

We believe that the slight weakness of the dollar might well go on for some time. The signs coming from the European and the Japanese economies will remain friendly for the time being and the elections are feeding a positive mood. This scenario is complemented by political pressure on China to allow for a further appreciation of the renminbi. Around mid-September, attention might focus on US monetary policy again. We do not see why the state of the US economy should prompt the Fed to stop raising the key rates, particularly as long-term interest rates failed to react to the monetary tightening and the real estate markets continue to boom as before. The US dollar might then be gaining ground again.

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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