Friday May 5, 2006 - 14:38:28 GMT
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FX Briefing 5 May 2006Highlights
â€˘ Fed to raise rate to 5% and remove standard sentence about further firming
â€˘ ECB will continue gradual tightening, provided the economy remains on track
â€˘ China concentrates on stimulating domestic demand to correct external imbalances
Euro reaches highest point so far this year
The dollar continued its descent this week, albeit at a slower pace than last week. EUR-USD traded mostly at just over 1.26, only moving to over 1.27 towards the end of the week, which is a 12-month high. The dollar weakened against the yen to 112.34 at the beginning of the week, but then hovered between 113 und 114 in quiet trading because of the bank holidays in Japan and China.
The current exchange rate development is influenced less by individual events or news than by two underlying currents: One is increased political interest in the reduction of the global current account imbalances, the other is that the ECB has replaced the Fed as the leading actor on the interest rate policy stage. This week monetary policy was again in the limelight. Some confusion was caused by reports of Fed chairman Ben Bernanke saying that the markets had misunderstood his recent monetary policy testimony before Congress.
It is in fact unclear what exactly Mr Bernanke said to a journalist at the official White House Correspondence Association Dinner. It seems more sensible, however, to stick with the â€śwritten wordâ€ť rather than unofficial fragments of conversation. In his testimony before Congress Mr Bernanke had indicated that the FOMC would consider pausing for a while to allow â€śmore time to receive informationâ€ť about the economic development and the effect of the previous interest rate hikes in particular. At the same time he emphasized that the FOMC considers inflation risks to be dominant for the time being and that taking a pause would not preclude interest rate hikes later. Supposedly he said to the journalist it was worrisome that anyone would think of him as dovish and that he had not announced that the Fed is done raising interest rates. This does not contradict what he said before Congress.
We think that the fed funds rate will be raised by another 25bp at the FOMC meeting next
Wednesday. The sentence that â€śsome further policy firming may be neededâ€ť is likely to be scrapped from the statement. This would pave the way for a pause at the end of June. At the same time the Fed will probably make it clear that inflationary risks are predominant given above potential growth, rising resource utilization and possible ripple effects of higher costs for energy and other commodities.
In the run up to the ECB Council meeting, favourable economic data and various Council members speaking of several interest rate increases and a normalisation of the interest rate level had fuelled speculation that the European Central Bank might be more aggressive in its tightening. But at the press conference after the meeting this week Mr Trichet gave no indication that the central bank would do so. He said several times that the ECB was very vigilant, which speaks pretty clearly for an interest rate step in June. Just like last month, he moreover pointed out again that meeting outside Frankfurt was no reason not to raise rates. So in this respect the ECB stuck to last monthâ€™s screenplay.
But with respect to the interest rate path in the further course of the year Mr Trichet remained relatively vague, just pointing out that the ECBâ€™s decisions were not predetermined. What he did say, however, was that monetary policy accommodation would be reduced further, assuming that the actual economic development follows the ECBâ€™s current main scenario. Apparently, the ECB is planning more than one further interest rate step, the way things look at the moment.
We see no indication, however, that the ECB is planning a 50bp step or a quicker succession of interest rate steps â€“ quite the contrary. Mr Trichet hinted that the new ECB staff projections would not be significantly different from the current outlook. In this case the plans for monetary policy should not be adjusted either. Mr Trichet again confirmed that price data show no second round effects so far. The fact that the interest rate hikes are still preventive also speaks for a moderate pace of monetary policy tightening. And finally, the euroâ€™s appreciation now seems to play a role in the ECBâ€™s considerations. At least Mr Trichet had reason enough to explicitly state (a) that the G7 communiquĂ© does not call for a change in the EUR-USD exchange rate and (b) that the ECB Council is aware of the risk posed by a disorderly correction of the global imbalances.
Because of the bank holidays in Japan and China, the Asian markets were relatively quiet. Market participants listened closely, however, to repeated statements from Japanese finance ministry officials, including finance minister Sadakazu Tanigaki, pointing out (just like Trichet) that the G7 communiquĂ© does not mean that the dollar should be devalued. Maybe the implicit threat of interventions and the generally higher readiness of the Asian central banks to intervene in the market is helping to slow the appreciation of the yen and other Asian currencies a little.
Next week the US Treasury will probably publish its Semiannual Report on International Economic and Exchange Rate Policies. It will be interesting to see whether the US administration will actually accuse China of currency manipulation. Chinese vice finance minister Jin Liqun just said something remarkable at the annual meeting of the Asian Development Bank in India: China was to put the focus of its adjustment measures on the stimulation of domestic demand; he rejected major exchange rate adjustments as this would be too heavy a burden on the economy. The finance minister, Jin Renquing, explained China would not bow to pressure from the major economies and the current exchange rate was appropriate.
Stephan Rieke +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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