Friday June 18, 2004 - 21:16:19 GMT
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Dollar Weakens As US Current Account Deficit Widens To Record
DailyFX Fundamentals 06-18-04
· US Current Account Deficit Widens To Record
· UK Mortgage Lending Slows
· Eurozone Trade Surplus Narrows
The Euro has ended the week higher amidst growing evidence of the need for a rate hike by the European Central Bank. The ECB, the world’s youngest central bank is very concerned with establishing credibility. The most recent tightening by the Swiss National Bank, the Bank of England and the upcoming expected tightening by the Federal Reserve will leave the ECB as the only major central bank aside from the Bank of Canada and the Bank of Japan have yet to raise rates since the global economy began to recover. With global inflation on the rise, the ECB may feel increasing pressure to prove themselves despite the possibility of risking their recovery. Annualized inflation for the month of May has increased a full half a percent, which was the largest gain in two years. Eurozone industrial production on the other increased a lackluster 0.2% in the month of April. Therefore this makes the ECB’s position particularly difficult. In the week ahead, we have a number of ECB officials speaking – look for hints on monetary policy and inflation. We are also expecting the ZEW economic sentiment survey and the IFO business climate survey. The German ZEW survey of analyst sentiment has been declining since December, while the IFO business climate survey has remained relatively stable.
The US current account deficit widened to a record $144.9 billion in the first quarter of 2004. The deficit is now 5.1% of GDP, up from 4.6% in the fourth quarter. The sizeable rise is quite alarming and stems from a sharp increase in imports from companies trying to meet rising domestic demand. Although the dollar has sold off on the release, losses were limited as the market’s core focus for the moment is on interest rates and not the deficit. Once the Fed finally ends speculation and begins raising rates, the deficit may have the chance at regaining the spotlight. Therefore if the deficit widens again in Q2, we may see a more notable currency reaction, especially since there is little evidence that foreign investors are willing to fund the deficit. The deficit is still covered primarily by official intervention. In the week ahead, as we have previously stressed, we expect more range trading leading into the June 30 FOMC meeting. The only notable releases from the US are durable goods on Thursday and the final first quarter GDP report on Friday. Meanwhile, it is a busy week for Switzerland. We are expecting industrial production, money supply, the trade balance and import prices.
The British Banker’s Association reported today that mortgage lending slowed during the month of May. Since this follows a record increase in the month of April, it is far too early to conclude from this data that the housing market may be beginning to slow. After 4 hikes since last November, the Bank of England is struggling to ensure that the market begins reacting to their tightening campaign. In the week ahead, the key release expected from the UK are the minutes from the June 9/10 MPC meeting at which the Bank of England raised rates by 25bp. The vote is likely to have been a close call – look for wording on further tightening biases. Currently the market does not expect the Bank of England to raise rates again on July 8th. Although the pound remains bid, if there is no further evidence of increased aggressiveness by the BoE, we could see the pound top out around 1.85.
According to the minutes from the Bank of Japan’s April 28 monetary policy meeting, the board members discussed the possibility of adopting a 1% CPI inflation target. However, with the economy still flirting with deflation, adopting an inflation target is not an immediate concern. In the week ahead, we are expecting the CPI report, which will give us more information on the deflation/inflation situation in Japan. BoJ Governor Muto warned that the BoJ is closely monitoring long-term rates, which hit a 45-month high yesterday. Although the rally in bond yields is reflective of the market’s optimism on the Japanese economic recovery, higher bond yields tighten the economy. If the tightening starts to damage the recovery, the BoJ may have to take appropriate measures.
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