Friday April 28, 2006 - 14:43:17 GMT
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FX Briefing 28 April 2006Highlights
â€˘ Bernanke hints at rate rise pause
â€˘ G7 decides to use exchange rate policy to help reduce global imbalances
â€˘ ECB prepares markets for several interest rate hikes
Policy shift weakens the dollar
This week the dollar was under attack from all sides. EUR-USD rose significantly over the 1.25 mark for the first time in eight months. The dollarâ€™s weakness against the Asian currencies was particularly marked: USD-JPY fell from over 117 to below 114. The renewed weakness of the dollar was primarily a result of the shift in monetary and exchange rate policy. Last weekend, the G7 nations decided on a coordinated approach to exchange rate policy aimed at helping to reduce global imbalances by means of exchange-rate adjustments. Moreover, Fed chairman Ben Bernanke hinted in his testimony before Congress that the Fed could soon pause in its tightening cycle after fifteen consecutive rate rises. As a result, EUR-USD shot up sharply at the end of the week.
In testimony before Congress, Mr Bernanke said that the Committee may at some point in the future decide to take no action at one or more meetings, even if in the FOMC membersâ€™ judgement the risks were not entirely balanced. This would allow more time to receive relevant information on the economic outlook. All in all, Mr Bernanke expects the US economy to moderate to a more sustainable pace after the strong growth in the first quarter. He sees growth risks mainly in the softening housing markets and the high commodity prices. These comments made the rate hike in May, which had already been priced in by the markets, much more uncertain. Subsequently, the dollar fell sharply because this weakened the argument of a rising interest-rate spread in favour of the greenback.
At the beginning of the week, the dollar had already weakened, particularly against the Asian currencies, because of the exchange rate policy change in the G7 countries. Surprisingly, the G7 finance ministers and central bank presidents agreed unanimously to appeal to the Asian countries, and in particular China, to allow their currencies to appreciate. The previous week, the IMF had already pointed out that global imbalances could not be reduced without a depreciation of the dollar. The IMF had been given the task of coordinating the negotiations between the countries with structural imbalances and working out corresponding suggestions as to how to reduce them. On the whole, players on the forex markets interpreted the final communiquĂ© as the beginning of a more active exchange rate policy in countries where there are substantial structural imbalances at present.
In the face of this political message, the release of favourable economic data for the US only managed to slow the dollarâ€™s decline. It is astounding that consumers in the US appear completely unfazed by the lacklustre real estate market and the rapid increase in commodity prices. The Conference Boardâ€™s confidence gauge rose to the highest it has been in four years. Orders were surprisingly good too: at a rate of over 6% they accelerated again significantly in March, which bodes well for a further pick-up in capital spending at the end of the first quarter. Even more impressive were the economic data for the euro area. At the beginning of the week the Belgian business climate showed a marked rise, and the ifo index, Italian and French business climate followed suit. The bond markets reacted to the ifo in particular, which is considered a leading indicator for European growth, and to the first German price data for April which was rather high with an increase of 0.4% mom. Thus the ground was already prepared a little for the comments from Lukas Papademos and Nicholas Garganas: the ECB Council members said, rather surprisingly, that the markets should be prepared for several interest rate steps this year. This is a significant change in the ECBâ€™s rhetoric. Previously an interest rate hike for June had been hinted at, but on the understanding that the ECBâ€™s subsequent actions would depend on the incoming data. Apparently the ECBâ€™s confidence in the strength of the economic upswing has increased further.
We therefore expect that after the Council meeting next week Mr Trichet will deliver the same message as his colleagues and prepare market participants for a 25 basis point interest rate hike in June. The markets have already priced in a very aggressive monetary policy. In particular, we think that the expectation of a bigger interest rate step in June is exaggerated.
Uwe Angenendt +49 69 718-4114
+49 69 718-3642
Foreign Exchange Trading
+49 69 718-2695
Matthias Grabbe / Klaus NĂ¤fken
+49 69 718-2688
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