Friday March 2, 2007 - 15:51:53 GMT
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Forex News - FX Briefing 2 March 2007
FX Briefing 2 March 2007
â€˘ Yen appreciates significantly due to marketsâ€™ reducing risk
â€˘ ECB to raise refi rate to 3.75% on Thursday
â€˘ 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 marketsâ€™ 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 Chinaâ€™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 banksâ€™ 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 â€“ an assessment supported by the ECB Councilâ€™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
+49 69 718-3642
Foreign Exchange Trading
+49 69 718-2695
Matthias Grabbe / Klaus NĂ¤fken
+49 69 718-2688
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