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Forex: Euro Rallies as ECB Reiterates Rate Hike Bias

DailyFX Fundamentals 02-09-06

By Kathy Lien, Chief Strategist of www.dailyfx.com

• Euro Rallies as ECB Reiterates Rate Hike Bias
• Rate Hike by SNB in March a Near Certainty
• British Pound Weakens Following Weaker Data

US Dollar

The performance of the US dollar against the majors has been very mixed today. The Euro managed to recover some gains, but the British pound and Japanese Yen continued to lose strength. Jobless claims increased to 277,000 for the week ending February 4, which brought the four week average to the lowest level since April 2000. The level of claims continues to suggest that the labor market remains healthy while hawkish comments from Fed President Moskow also helped to boost the dollar. Moskow, who is a nonvoter said that interest rates are currently at a “neutral level” but more rate hikes may be needed, even preemptive ones in order to keep inflation expectations anchored. The rally in the dollar against the Japanese yen was particularly strong thanks to suspected demand by the Japanese for the newly reintroduced 30-year bonds. Although the Treasury felt that demand was superb, the amount of bids received was slightly less than forecasted. Tomorrow we are expecting the only piece of data due for release this week that could potential give us some new talking points. The US trade deficit for the month of December is expected to widen from -$64.2 billion to -$65 billion. Holiday shopping is should have boosted imports while a decline in aircraft orders should have weighed on exports. Even though oil prices were softer in the month of December, higher import volumes should have offset any potential improvements. The futures contracts continue to price in a very high likelihood of a March rate hike followed by the growing possibility for a May hike as well. Trading continues to remain quiet. With the US dollar trading near its highest level against the Euro and Japanese Yen since the beginning of the year, the market is getting a bit overextended and as a result, may need a clear catalyst before pushing even further.

Euro

Trading in the Euro remains quiet today as the currency fluctuates within a tight range against the US dollar. The Euro is getting a boost from new developments on Russia’s Paris Club debt repayment and the release of the European Central Bank’s monthly bulletin. According to the Russian Finance Minster, the country plans on repaying another $10-12 billion of their Paris Club debt this year. In order to repay this debt, Russia would need to purchase a large amount of Euros. Meanwhile the monthly bulletin released by the European Central Bank confirmed the hawkish comments recently made by both Trichet and Liebscher. The report warned that the central bank will have to remain vigilant since inflation still has the risk of ticking higher. In other words, the ECB is essentially telling us that they plan on raising interest rates relatively soon. For those who have been trading the FX market for the past 2 years, you may recall that the ECB likes to prepare the market for an impending change to their monetary policy. Unlike Greenspan who preferred the surprise factor, the ECB frequently gave the market a chance to price in a potential change in rates before actually making a change. In doing so, they are trying to prevent any sharp unwanted movements. The big surprise today actually came from Switzerland which reported a sharp jump in consumer confidence in the first quarter. The index leaped from -15 to +2, the first time in 4 years that the index is back in the green. The Swiss National Bank is on path to raise interest rates by a quarter point in March. SNB Roth indicated that there should be no surprises at the next meeting and judging from his comments and the market’s expectation, we take that to be a confirmation for a rate hike.

British Pound

The British pound sold off against the dollar for the fifth consecutive trading day following a dose of weak economic data. The house price survey published by Halifax indicated that the value of homes fell for the first time in eight moths by 0.4 percent. This comes after two months of strong price increases. The trade deficit for the month of December also jumped slightly from GBP6.01B to GBP6.06B. Although the rise was nominal, the big disappointment was that the market had expected the trade deficit to improve and on top of that the deficit for the month of November was revised to a larger figure. Even though the Bank of England left rates unchanged as expected, the market still continues to mull over the possibility of another interest rate cut by the Bank of England.

Japanese Yen

The Yen took another tumble today on speculation that the Japanese may have been big buyers at today’s 30 year Treasury auction. The Bank of Japan delivered no surprises as they left both monetary policy and their outlook on the economy unchanged. For those who have been hoping for a rate hike thanks to a recent fund advisory report, BoJ Governor Fukui’s lack of a clear answer on whether monetary policy will be changed at the next meeting may be an indication that they have yet to get the green light from the government to end quantitative easing. We do not expect the government to budge anytime soon. Analysts are predicting a possible rate move in April, but we think that this timing may still be a bit optimistic given the fierce battle that the Japanese government has put up over the past few months.

 

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