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Friday March 31, 2006 - 16:08:04 GMT
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FX Briefing 31 March 2006

• Ifo data probably exaggerate momentum of EMU economy
• Chinese weeks in Washington: US pushes for more flexible CNY
• UAE central bank (openly!) discusses boosting its holdings of euros

ECB: No shots from the hip

Another marked improvement in the ifo business climate and US consumer confidence, together with the Fed’s implication that further tightening will be needed, resulted in the bond markets suffering significant losses world-wide. However, due to the contradictory factors cancelling each other out, the forex market remained relatively stable. During the first half of the week, EURUSD tended mainly towards the 1.20 mark. The dollar’s fractionally firmer tendency was only broken temporarily by the ifo data. In contrast, the dollar weakened somewhat against the yen initially. Before the release of the consumer climate data and the FOMC decision, it slipped below 117, at times even below 116.50. Afterwards, the US currency strengthened to around 118.

But as from Thursday afternoon, the dollar began to crumble: EUR-USD climbed to a peak of 1.2176 and was about 1.21 towards the end of the week. USD-JPY fell – somewhat more moderately – to around 117.50. The high yield currencies, including the Aussie and the kiwi dollar, the real, the rand, the eastern European and Scandinavian currencies including the Icelandic krona, which had all taken a dive during the last few weeks, managed to recover slightly at the end of the week.

The reasons for the recent – albeit slight – weakening of the dollar are not easy to grasp. Those who thought that the latest improvement of the ifo business climate indicated that a European economic boom and significant monetary policy tightening were imminent, were probably on the sell side. Although our view of the European economy has been upbeat for some time, we warn against expecting too much. The weaker German labour market data in March and retail sales in February illustrate that there are still limits to the positive trend at the moment. It should also be noted that the (short-term) interest rate spreads between the US and the EMU have remained much the same; thus the markets as a whole are not expecting the interest rate gap to narrow more rapidly at present.

During the last few weeks, the Americans have been renewing their efforts to push for a more flexible renminbi exchange rate. The US administration has several opportunities to increase public pressure on China: President Hu Jintao’s visit to the USA (meeting with President Bush in the White House on 20 April), the legislation proposed by Senators Lindsey O. Graham and Charles E. Schumer, and just recently, Senators Grassley and Baucus, and the presentation of the bi-annual Treasury report on international exchange rate policies (publication postponed until the end of April). The campaign underlines the US government’s strong interest in a depreciation of the dollar against the renminbi and other Asian currencies and in a correction of the current account balance.

Fitting in with this, there were rumours on Thursday afternoon that Secretary of the Treasury John Snow had spoken out in favour of a dollar depreciation. Furthermore, there was a press report that the new Chief of Staff in the White House, Joshua Bolten, was aiming to replace Mr Snow. Both the Treasury Department and the White House promptly denied this; the ministry repeated the standard strong dollar phrase and President Bush expressly backed his economic team.

Finally, an interview with the governor of the central bank of the United Arab Emirates stirred up the forex markets. According to governor Sultan bin Nasser al-Suwaid, the central bank might raise the euro share of its foreign reserves, a total of more than US$23bn, from 2% to 10%, at the expense of the dollar share. He said that the central bank wanted to profit from the euro appreciation it expects to take place during the course of this year.

At the beginning of the month, market participants are usually flooded with important data. These include sentiment indicators such as the ISM index and Reuters European purchasing managers’ indices. Moreover, the Tankan for the first quarter will be published in Japan. The general trend for all these data is positive. We think the main focus should be on the European figures, and the German ones in particular. The ifo figure was extremely positive and it remains to be seen whether the Reuters PMI, industrial production and new orders can match this. This is not certain, as the unusually cold weather could have dampened the development.

The ECB Council will meet on Thursday and the markets seem to be expecting a signal that the ECB will accelerate the pace of interest rate hikes. We are sceptical, however: so far growth has developed as the ECB expected. A stronger pick-up in growth in Q1 – if it materializes – might just be due to the weaker than expected fourth quarter. In our opinion, market expectations about the ECB’s interest rate increases are a little over the top at the moment.

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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