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FX Briefing: Euro is winner of the week

FX Briefing 28 October 2005
* ECB prepares the ground for interest rate increase
* Bernanke and the genie in a bottle
* Ifo indicates strong start to fourth quarter

Euro is winner of the week

The euro’s recovery continued this week. At around USD1.2150, it was significantly above the 15-week low reached in the middle of last week. The yen, on the other hand, remained
weak. After further disappointing economic data from Japan, USD-JPY temporarily rose to over 116 only to fall below this level again later. Thus the euro is the winner of the week amongst the major currencies. At around 140, EUR-JPY has now reached what, over the last seven years, has always proved to be a significant resistance level.

This week the euro was boosted mainly by the economic data from both sides of the Atlantic. In Europe, the marked improvements in October business climate indicators in Belgium, France, the Netherlands and particularly in Germany, were quite unexpected. Despite the burdens on the European economy resulting from the high oil prices, the mood within companies is improving continually. Thus the ifo economic gauge rose by a stunning 2.7 points – the highest increase in the last five years. The statistics indicate a very successful start to the fourth quarter. In the third quarter, GDP growth was probably already at the upper end of the EU Commission’s forecast of 0.2 to 0.6 per cent. In view of the improving growth outlook, the ECB could be forced to take action in the near future. In any case, the council members are taking every opportunity to stress their increased vigilance in the light of the high commodity prices.

We still consider that December could be a possible date for raising the interest rate. The ECB will adjust its projections in its last meeting of the year. We are no longer expecting a downward growth revision for 2006. On the contrary, the growth forecast could even be raised slightly. However, the inflation forecast will probably be adjusted upwards for the third time running to an average of 2.25 per cent. Last December, the ECB was still assuming that the inflation rate in the year 2006 would be within the region of 1.6 per cent.

Although this is mainly a result of the energy price development, indirect price effects must also be reckoned with in 2006. Even if oil and petrol prices fall, it will probably take some time for the inflation rate to drop back from its present high level. As growth increases, the council members will also place more emphasis again on the strong increase in monetary growth as a potential inflation risk. In order to nip second round effects in wages and inflationary expectations in the bud, the ECB will, in our opinion, act swiftly. Thus the European common currency was boosted by two factors: the expectations that the interest rate spread to the US could narrow again, and the improving growth outlook for the eurozone.

The weaker economic data in the US is also likely to have acted in favour of the euro. And the early nomination of Ben Bernanke as successor to the legendary Alan Greenspan might have helped too. The prevalent opinion on the markets seems to be that the new Fed governor might be less hawkish than his predecessor. This assessment is probably based on the fact that in the low-interest rate phase Mr Bernanke made a name for himself as an aggressive deflation fighter.

However, we do not share this opinion. In his numerous speeches as an FOMC member he left no doubt that he takes the pursuit of stability seriously: Before the Fed actually adopted its policy of measured interest rate steps in May 2004, he pointed out that, if in doubt about the tenacity of inflationary pressure, it could be advantageous to take a more aggressive monetary policy stance to prevent the inflation genie escaping from the bottle.

From the exchange rate point of view it is also interesting that Mr Bernanke does not believe the reasons for the high current account deficit to be primarily rooted within the US. He argues that the deficit is mainly the result of the high propensity to save elsewhere, particularly in industrializing and developing countries. According to Mr Bernanke, the surplus countries thus hold the key to reducing the global imbalances since they should actually be capital importers given their present stage of development and their demographics. Because of the high savings in the rest of the world, he sees no immediate problems in sustaining the US current account deficit.

Next week the markets will be held in suspense by the central bank meetings of Fed and ECB. Since a further hike in US interest rates to 4% has been fully anticipated by the market, the ECB Council meeting has the most potential for surprise. Based on the reasons described above, we expect Mr Trichet to prepare the markets for an imminent interest rate increase.

Uwe Angenendt +49 69 718-3648
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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