Friday January 20, 2006 - 16:03:26 GMT
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FX Briefing 20 January 2006FX Briefing 20 January 2006
• Forthcoming Fed meeting casts its shadow
• ECB adopts more hawkish tone
• First inflation data of the year unfavourable for the eurozone
EUR-USD remained more or less unchanged this week. After a firm start, the single currency dropped again gradually. At USD1.2080, the euro is in the middle of the trading range of 1.20 to 1.22 in which it has been since the beginning of the year. The yen also weakened against the greenback during the course of the week. However, the fact that the dollar held its ground cannot really be attributed to a great change in the fundamentals. Thus the Nikkei’s temporary plunge probably also had some impact on the forex markets.
At least last week’s economic indicators did not lead to a radical change in the assessment of the US economy. The data paints a mixed picture: the rise in industrial production was higher than expected by the market, but the increase was mainly due to energy. The first business climate indicators for January for the New York district and Philadelphia were significantly weaker at first glance. However, the sub-components indicate that the ISM index could have risen again substantially in January after the weak December figures. Housing starts were very weak which could be a sign that the real estate market, which is important for private consumption, is cooling down.
With regard to US monetary policy, it was particularly interesting that capacity utilization rose again with the positive production figures and is now above the long-term average. As the leading indicators for the labour market are suggesting quite a favourable development in January, resource utilization, which the Fed is watching closely, could have increased further. Also the prices-received component in the Empire State Manufacturing index increased again in January. It has been rising continuously since last August – an indication of increasing leeway for passing prices through to consumer prices.
In preparation for the Fed meeting on 31 January, this data could have contributed to the markets’ dwindling confidence in an end of the tightening cycle in the near future. Fed governor Susan Schmidt Bies and Richmond Fed President Jeff Lacker took a somewhat less hawkish stance in their speeches this week. They warned of possible ripple effects of the high energy prices and of bottlenecks due to companies’ high utilization.
Uncertainty about the future direction of monetary policy has increased in Europe too. Thus ECB executive board member Lorenzo Bini Smaghi surprised the market with his comment published in the media mid-week that he considered interest rates too low and was in favour of further rate rises. These remarks were later denied, but that did not alter the fact that markets started placing more weight on increasing interest rates again. The change in expectations was backed up by his executive board colleague Ottmar Issing’s comments that he did not think the energy price development posed increased growth risks for the eurozone; in fact the risks for domestic demand had declined. Furthermore, the ECB’s Monthly Bulletin took a slightly more hawkish tone again.
It will probably be difficult for EUR-USD to break out of its trading range in the coming weeks. We are expecting better economic data from the US, including the ISM and the January labour market report. Given the sustained increase in resource utilization and the high energy prices, the Fed will raise its key interest rate by another 25 bp at the end of the month. It is unlikely to change its statement significantly since inflation risks have increased rather than decreased. If capital market rates remain unchanged, this hike will lead to a clearly inverted yield curve. But in view of favourable US economic indicators, this inversion will not last in our opinion.
In the euro area, interest rate raise speculation will be fuelled by the January price data. We expect EMU inflation to jump from 2.1% to 2.6%. Such a high rate at the beginning of the year might force the ECB to raise its inflation forecast for 2006 again in March. We are still expecting the next ECB rate hike to take place in March. German price data next week will give us a first indication of the inflation development in January.
Uwe Angenendt +49 69 718-3648
+49 69 718-3642
Foreign Exchange Trading
+49 69 718-2695
Matthias Grabbe / Klaus Näfken
+49 69 718-2688
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