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Wednesday October 5, 2005 - 20:35:47 GMT

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Forex: Dollar Moderately Weaker on Sharp Contraction in Service Sector Growth

DailyFX Fundamentals 10-05-05

· Dollar Moderately Weaker on Sharp Contraction in Service Sector Growth
· Stronger Data Helps to Boost Euro
· Bank of England Expected to Leave Interest Rates Unchanged

US Dollar

The dollar has given up some of its gains today as the Euro crawls its way back from the 1.1901 low hit yesterday. The move today though is hardly impressive with the currency pair up only 50 somewhat pips from yesterday’s low, especially following today’s sharp disappointment in the ISM non-manufacturing survey. The US service sector report plunged to the lowest level since April 2003 with a corresponding fall in the employment component. As we edge closer to Friday’s non-farm payrolls report, the disparity between what the manufacturing and non-manufacturing sectors are signaling is making a prediction for Friday’s report all that more difficult. Today we published our non-farm payroll preview on our homepage and as far we stand, the slide in confidence and drop in help wanted ads suggest that the risk is to the downside. However the Challenger group reported 71.8k layoffs in the month of September, which is not that much higher than the 70.6k reported back in August. The report suggests that the additional job loss from the hurricane was nominal. What we are sure of is that the market will probably act more violently to a weaker number rather than a stronger number. It should come as no surprise that speculators in the market are extremely long dollars at this point. The FXCM Speculative Sentiment index continues to signal more losses in the EURUSD (we will be publishing our regular weekly SSI report tomorrow at 10:30am EDT). This means that there probably aren’t that many buyers left in the market while adamant dollar bears could be waiting on the sidelines for the momentum of a bad number to start snapping up the EUR/USD at a bargain. So watch out, Friday could deliver some interesting price action.


The euro is bouncing against the dollar thanks to strong numbers this morning. Retail trade increased 0.9% in the month of August while the service sector PMI survey advanced from 53.3 to 54.7. Germany and Italy both experienced improvements but France, the usual laggard, experience a slowdown in growth. Overall though, good numbers in both the manufacturing and non-manufacturing sectors with improvement in the employment component certainly prove hopeful for the Eurozone economy. The weaker euro and falling oil prices is providing a double stimulus for the region. The European Central Bank is set to announce another interest rate decision and although we expect no change in interest rates, the recent data does supports their more hawkish stance. Politically, without getting too excited because politics can change as regularly as the direction of the wind, Schroeder and Merkel seemed to be making progress on their coalition talks and are moving forward towards a coalition government with power shared by both parties. This would be the first time since 1969 that the two parties may be running the government together, which is actually quite interesting because collaboration may be the answer to resolving policy differences and allow the group as a whole to push through reforms. An agreement is targeted to be reached by October 18th, the first day that the new parliament will hold their session, which would also mark the end of Schroeder’s term.

British Pound

In contrast to the Eurozone, the UK’s service sector PMI index fell in the month of September from 55.2 to 55.0 which is the slowest pace of growth in nine months for a sector that accounts for close to 75 percent of the country’s economy. The reaction in the pound has been limited with earlier losses quickly erased. All eyes will be turning to tomorrow’s Bank of England rate decision. The central bank is expected to leave interest rates unchanged at 4.50 percent after having cut them by a quarter of a point in August. Although BoE officials have expressed concern about the downside risk to growth they are not expected to move on rates again till next year since inflation has been a major cause for concern, reaching 2.4 percent in August, which is the highest pace of growth in eight years. Also, the impact of the hurricane in US has already spread to companies abroad. British Petroleum announced yesterday that the hurricane has wiped $700 million from third quarter profits while British Airways announced today that they would not meet their return on sales target because of high fuel prices.

Japanese Yen

The Japanese Yen is firmer against the dollar today as we see some bulls take profit ahead of the 115 level, which is sure to be a tough barrier to break. The slide in oil prices is being modestly positive for the yen as optimism lingers following comments by Bank of Japan board member Haru who suggested that interest rates could be increased in early 2006. However the rally in the Japanese yen looks limited and could be easily erased tomorrow. The dollar’s growing interest rate advantage over the Japanese yen seems to be the predominant theme at this point with the market expecting two more rate hikes this year. Therefore even if Japan does seriously consider raising interest rates, it wont be till next year, which means that it will probably not be a focus until after the market has completely priced in the end of the Fed’s tightening cycle.


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