Monday November 21, 2005 - 11:12:27 GMT
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INVESTICA Ltd - www.investica.co.uk
ECB Chairman Trichet gave a very clear hint that Euro interest rates were set to rise and a 0.25% increase appears certain at the December 1 council meeting. It has been apparent for weeks that hard-line elements in Germany have been pushing for a tighter policy and Trichetís comments suggest that there is now majority support for an increase to curb inflation expectations and control money supply growth. The Euro pushed to a high of 1.1790 against the dollar before weakening back to around 1.1710 and secured a further rally in late New York to 1.1770. The Euro was holding firmer at 1.1780 in early Europe on Monday before pushing above the 1.18 level.
The prospect of an ECB rate increase will continue to underpin the Euro, especially as US bond yields have edged lower this week. The spread between US 10-year bonds and German bunds has narrowed to below 100 basis points and this will lessen the potential for near-term dollar buying. There will also be the potential for position adjustment and a further correction after recent strong dollar gains. Markets will be reluctant to give up on the US currency, especially with confidence over further interest rate increases in the US. The overall yield structure will also offer further dollar support, but the US currency will find it more difficult to make renewed gains in the short term.
The reported comments from G7 officials on Friday were potentially important. The remarks suggest that G7 members are happy with the dollar at current levels, but will aim to curb volatility. There also appear to be suspicions that the dollar gains will not be sustainable given the US external deficits. The capital repatriation levels are likely to decline from early this week and this will lessen the potential for dollar gains.
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