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FX Briefing

FX Briefing 25 November 2005

Highlights
• Forex markets preoccupied with to and fro of monetary polic
• Fed remains clearly the more aggressive central bank
• Economic data confirm robust US economy

Monetary policy brings movement into EUR-USD
It is nothing new that central bank policy in the major currency areas is currently having a strong influence on EUR-USD. However, this has been particularly noticeable this week. First of all, ECB President Jean-Claude Trichet pushed the euro up sharply last Friday. He surprised the markets by announcing that an ECB interest rate rise was imminent. As a result, EUR-USD rose at the beginning of the week by over 1.5 cents to almost 1.1850. This was partly due to the fact that market participants had interpreted Mr Trichet’s statement as signalling the beginning of a series of ECB interest rate increases.

Then at the beginning of the week, Mr Trichet sent the euro skidding down again by saying in a hearing before the European Parliament Committee on Economic and Monetary Affairs that it was not a good working hypothesis to bank on a series of interest rate rises right from the beginning. Subsequently, the euro fell again by over 1 cent.

Then, for a change, the euro got some support from the US central bank. The minutes of the last FOMC meeting revealed that the central bank members had given a lot of thought to changing their wording on future interest rate policy in the near future. Up to now, the Fed has always stressed that monetary policy accommodation can probably be removed at a measured pace. Furthermore, for the first time, a few FOMC members expressed concern about possibly going too far with the tightening process. The market therefore interpreted the minutes as an indication that the interest rate rising cycle might soon be coming to an end. Thereupon EUR-USD rose again significantly to over USD1.18. During the course of the week it was then halted again by a weaker Ifo indicator and considerably lower prices in Germany, which further cooled down speculation on interest rate rises in the euro zone.

This week’s monetary policy to-ing and fro-ing has not changed our assessment of the ECB’s or the Fed’s future monetary policy. We still think that the upcoming interest rate hike on 1 December will only be the first of several interest rate steps which will take us to a neutral interest rate level in the euro area. According to our calculations, this is around 3%. Unlike the Fed up to now, the ECB is not going to spell this out in advance but make its interest rate decisions dependent on the growth and price data. Based on our inflation and growth forecast, we think it plausible that the central bank rates will be tweaked up a little every quarter.

In our opinion, the Fed’s announcement to change the wording of the FOMC statement does not mean that the end of the interest rate cycle is imminent, but rather that the Fed will not tie itself down verbally in future. Its actions will depend on the incoming economic data. Therefore America’s monetary policy will be far less predictable.

The protocol of the FOMC meeting also showed, however, that the Fed expects the economic development to remain robust in the next quarters, which will require a further tightening of the reins. We still expect the fed funds rate to reach 5% by spring. Chicago Fed’s Michael Moskow indicated as much: he believes that further interest rate increases are necessary. In his opinion, interest rates could even move beyond the neutral level given that the inflation rate is at the upper limit of the Fed’s comfort zone. We thus still see the Fed clearly as the more aggressive central bank, which speaks for the dollar.

Next week’s economic indicators are likely to confirm the strength of the US economy once again. The GDP data for the third quarter will probably be revised up and the ISM will remain high. But the focus will be on the labour market data due at the end of next week. We expect a strong increase of over 250,000 in non-farm payrolls after the rather disappointing October figures. The personal consumption expenditure (PCE) deflators will also be closely watched. We forecast a month-on-month increase of 0.3% for the core rate, which means no all-clear on the inflation front.

Uwe Angenendt +49 69 718-3648
Economics Department
+49 69 718-3642
volkswirtschaft@bhf-bank.com
Foreign Exchange Trading
devisenhandel@bhf-bank.com
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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