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Friday February 24, 2006 - 16:30:43 GMT
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FX Briefing 24 February 2006: ECB: Interest rate rise number two

FX Briefing 24 February 2006: ECB: Interest rate rise number two
• Yen gains on confirmation of BoJ policy shift
• EUR-USD hovers around 1.19
• Sustained growth in the eurozone brings further interest rate hikes
ECB: Interest rate rise number two

The Bank of Japan is making it increasingly clear that its quantitative easing strategy will come to an end in the foreseeable future. Central bank governor Toshihiko Fukui remarked that the BoJ would change its policy when consumer prices showed a stable uptrend. He said that at the moment this development was just beginning; increases in core consumer prices would become clearer in future. The phase of reducing liquidity (from around ¥33trn at present) to the required level (about ¥6trn) could take several months. During this period, the overnight interest rate would remain at around zero. The interest rate is to be raised to a neutral level “at some point”.

Governor Fukui’s comments, which were relatively forthright for a central banker, kept markets, which had just relaxed a bit, from getting overly enthusiastic. Practically the whole Japanese yield curve shifted upwards; the yield on 10- year JGBs increased by 8 points to 1.60%. The slight recovery of USD-JPY and EUR-JPY in the last few days was also wiped out by Mr Fukui’s remarks. Both dropped by about 2 yen to just under 117 and 139 respectively.

In contrast, during the course of the week, EURUSD moved around 1.19, with only slight fluctuations. In the first half of the week, the dollar rallied somewhat. This was probably partly due to the markets’ risk assessment prior to the release of the FOMC minutes and later the release of consumer prices. Recently, inflation risks had played an increasingly prominent role in Fed statements; moreover, the increase in the producer prices core rate had alarmed market players. However, there were no big surprises after all: the minutes were in the mildly hawkish tone which had been expected. Despite the significant rise in the consumer prices’ headline rate, the more important CPI core rate developed slightly better than expected, taking the downward revision for December into account. From about Wednesday on, EUR-USD got more support from favourable EMU data. The most important news was the continued improvement in the ifo business climate which reached its highest level since the reunification boom.

The disappointing data on GDP growth in the EMU, particularly in Germany and France, can be regarded as a mere blip. Firstly, we know by experience that European statistics clearly underestimate growth in their preliminary data. On the basis of preliminary data for the years 1999 to 2004, the average annual growth was 1.6%; However, the revised data showed an actual growth rate of 2.0% per annum. Secondly, all the signs are indicating that economic activity in the eurozone will continue to develop favourably.

In February, the ifo business climate index climbed to a 14-year peak. As in January, all industrial sectors registered improvements, which is a very good sign. The mood in the retail trade brightened up particularly, but the construction industry is also starting to see a light at the end of the tunnel. Not only is there more activity in the strongly export-oriented manufacturing industry, but domestic demand seems to be picking up too. The GfK index, which shows a further improvement in the consumer climate, confirms the trend.

There are positive signals from France too. Business confidence rose from 103 to 105 and is thus back at the high level of 2004. The assessment of production prospects is on the whole slightly more cautious, but people are considerably more optimistic for their own companies. In January, consumer spending for manufactured goods rose substantially by 0.9% month-on-month in real terms. Thus at least the start of the first quarter was positive. If the January level were sustained only, there would still be a plus of 0.8% over the fourth quarter.

Despite the moderate Q4 growth rate, the ECB Council, which is meeting next Thursday, has no reason to revise its December growth forecast down (2006: 1.9%, 2007: 2.0%). The EU Commission, for instance, has just confirmed its euro area growth forecast of 1.9% for 2006. The climate indicators would in fact justify a slight upward revision – the Greek central bank president Nicholas Garganas indicated as much. In any case, the positive growth outlook is now better supported because of the favourable trends in the US and Japan.

The ECB’s inflation projection of 2.1% for this year also seems to be on track. Admittedly, energy prices are somewhat more elevated than the ECB had assumed in December and, given the developments in the Middle East and Nigeria, the risk of oil price spikes has not become any smaller. In addition, the ECB is putting increasing emphasis on the development of house prices Against this background, a further systematic reduction of the ECB’s monetary policy accommodation can be expected. There is no doubt that the refi rate will be increased by 25bp to 2.5% next Thursday. The market is expecting further rate hikes of 25bp per quarter until autumn. It will be interesting to see whether the ECB will signalize an acceleration of its tightening pace.

Stephan Rieke +49 69 718-4114
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.
© 2005 BHF-BANK Aktiengesellschaft
All rights reserved. Please mention source when quoting from it.


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