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Friday March 2, 2007 - 15:51:53 GMT
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Forex News - FX Briefing 2 March 2007

FX Briefing 2 March 2007
• Yen appreciates significantly due to markets’ reducing risk
• ECB to raise refi rate to 3.75% on Thursday
• ECB projections: growth slowing down slightly, inflation on target

ECB caught between a rock and a hard place
This week, forex markets were dominated by the massive unwinding of carry trades. During the course of the week, the yen firmed over 3% against the dollar and the euro to about 117 and 154 respectively. Against high-yield currencies such as the South African rand, the Turkish lira, the New Zealand dollar and the Brazilian real, the correction was even more dramatic, with the yen gaining as much as 5 to 6%. The other low interest funding currencies including the Swiss franc and the Czech koruna, stood their ground relatively well. EUR-USD firmed initially to over 1.32, but the market relinquished its gains after relatively favourable ISM data. At the end of the week, EUR-USD was on about the same level as last Friday at 1.3170.

The hasty purchase of yen this week was partly a result of financial markets’ reducing risk across the board. The yen rose as equity prices dropped and credit spreads widened. As is often the case in volatile times, it is difficult to find an explanation for the movements: they seem to have been triggered by the collapse in Chinese share prices. However, despite China’s increased global significance, it is hardly plausible that a global crash could be caused by what happens on the Shanghai Stock Exchange, particularly as rumours about restrictive economic measures to be taken by the Chinese government seem to have sparked the collapse there. Weaker US economic data, ambiguous comments from former Fed chief Alan Greenspan plus indications of sustained, or possibly even worsening, problems on the US housing market are likely to have played at least as important a role.

However, it should be borne in mind that equity prices had been rising sharply worldwide for months (ever since spring 2003 in fact), the yen had depreciated significantly, and risk premiums as illustrated for example in the implied volatility on stock and forex markets had fallen to exceptionally low levels. In this sort of environment, even the very slightest disturbance can be enough to trigger a correction.

ECB: interest rate rise imminent, but outlook open
The ECB is facing a difficult task next Thursday. On the one hand, the European economic indicators are solid for the most part. A few German indicators such as the ifo index, consumer climate data and retail sales have weakened recently. But a slight setback had been expected for 2007 due to the German VAT increase; further more, the data in other European countries (France and Italy) turned out to be better than expected.

On the other hand, the tremors in the financial markets could well herald a weakening economy. At any rate, the US economy has just been chugging along for the last three quarters, without any sign of things improving in the near future. The problems on the housing market do not seem to be over yet, especially as defaults in subprime lending are increasing and the banks’ loan policies are becoming more restrictive.

Central banks are efficient fire fighters, but they tend to wait until the whole building is on fire before sounding the alarm. For in real emergencies, the emergency exit is usually too narrow anyway. Therefore, why cause a panic if the whole thing might only be a false alarm or the inhabitants of the house might be able to extinguish the fire themselves?

Thus the ECB will probably just issue soothing comments on the current developments on financial markets. Presumably, the central bank will highlight the favourable economic outlook – an assessment supported by the ECB Council’s latest projections and in line with the announced interest rate rise to 3.75%. The events on the markets will probably be described as a healthy correction of past exaggerations.

But despite its display of confidence, the ECB is also likely to point out that subsequent interest rate decisions are completely open. We are expecting the central bank to reduce its inflation projection for 2007 to at least 1.8%, or possibly even to 1.7%. The forecast for 2008 could be reduced slightly to 1.8%. Given the favourable, on target inflation forecasts, there might even be a possibility of the ECB signalling that the end of the tightening cycle is approaching.

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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