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Friday November 11, 2005 - 22:46:35 GMT
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FX Briefing 11 November 2005

• Uncertainty about first ECB rate rise on 1 December
• Euro weakened by riots in France and German coalition talks
• US trade deficit reaches new record high in September

Euro tumbles to two-year low despite record US trade deficit

Hardly any indicators were released at the beginning of this week and the situation on the forex markets remained much the same. Despite a record deficit in the balance of trade, published on Thursday, the dollar continued to be strong against the euro and the yen. Towards the end of the week, the Japanese currency rallied slightly compared with the previous week to 118.1, but the euro fell to a two-year low of 1.1695 after a significant improvement in US consumer confidence. The yen was thus able to stage a modest recovery from last week’s low against the euro of over 141, and is now around 138.2.

At first glance, the euro’s weakness is surprising. At the moment, ECB representatives are constantly warning about inflation risks and thus highlighting the possibility of an interest rate hike in December. But EU finance ministers have urged the ECB not to take hasty monetary decisions. This has raised doubts on the markets as to whether the ECB will really take the plunge at its next meeting to raise the refi rate which has been 2% for two and a half years. However, we are still expecting the ECB to increase the interest rate to 2.25% on 1 December. For its latest projections will be presented on that date, which will probably confirm the assumption of consolidated EMU growth. With respect to the inflation rate, the ECB is likely to raise its 2006 forecast to over 2%.

As far as US monetary policy is concerned, there is no doubt that the Fed will continue with its policy of interest rate hikes. This is not even likely to come to an abrupt end under the new chairman Ben Bernanke as from February. Fed funds futures are pricing in a level of 4.75 to 5% by summer. Monetary policy in the US is also giving priority to supporting price stability in the face of increasing inflation risks. According to William Poole of the St. Louis Fed, the fed funds rate is now much closer to neutral than a year ago. However, alternate FOMC member Sandra Pianalto, has stressed that the Fed does not have a fixed numerical interest rate target but that the interest rate policy depends on economic conditions.

Thus the interest rate differential will continue to be in the dollar’s favour for the time being. Developments within the EMU have probably also weighed on the European single currency. These include the continuous riots in France which highlight the political challenges posed by the considerable social inequality also in existence in Europe. The bickering during the German coalition talks has probably also had a negative impact on the euro. For so far the main things that have leaked out to the media are the additional tax burdens which are likely to be introduced to make up for budget shortfalls of at least €35bn. This would place quite a heavy burden on consumption, which is weak as it is. Coalition negotiations should be concluded today. If the coalition does manage to agree on some relief, e.g. for non-wage labour costs, to balance the tax increases, this could have a positive impact on the euro in the short-term.

US trade deficit over $66bn
The increase of the US trade deficit in September by around $7bn to a record high only caused ripples on the forex markets on Thursday and did not weigh on the dollar on the whole. This is probably due to the fact that in addition to the Boeing strike, the increase was related mainly to the disruptions caused by the hurricanes and the subsequent sharp rise in the oil price. Furthermore, the previous day, William Poole had emphasized again that the high deficit was due to international capital flows rather than structural imbalances in the US economy.

Therefore, next week financial markets will be waiting to see whether foreign purchases of US securities in September were significantly higher than the trade balance deficit again. Interest will also be focused on inflation data, industrial production and retail sales for October. These will probably be mixed on the whole. Additionally, the first two purchasing manager indices for November will be released. However, they are expected to underline the robustness of the US manufacturing industry.

In the EMU, the main focus is likely to be on the GDP figures for Q3 from Germany, Italy and the EMU. Like the estimate for France, the growth rates will probably be significantly better than in Q2, which will strengthen the arguments for an interest rate rise on 1 December.

Peter Meister +49 69 718-2600
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.
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