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Friday June 1, 2007 - 15:22:39 GMT
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Forex Market News - FX Briefing 1 June 2007

FX Briefing 1 June 2007
• Chinese stock market dive has no ripple effects
• US indicators support recovery scenario; euro area still booming
• ECB wants to move away from key words

Dollar steady in turbulent conditions
It was an eventful week, but the dollar remained more or less unfazed. On Friday it was quoted at
1.343 – the same level as last week, after the euro had to relinquish its earlier slight gains. The yen also remained very weak. It rose temporarily when the Chinese stock market took a dive, only to fall back again. USD-JPY closed out the week at around 122, which is the lowest level in three-and- a-half months. Versus the euro, the yen also remained close to its all-time low.

Investors were momentarily rattled by the Chinese stock market drop. High-yield currencies temporarily weakened while the borrowing currencies. i.e. the yen and the Swiss franc, benefited. The Chinese stock market came under pressure when Beijing tripled the stock trading tax to stop the market from overheating any further. China’s benchmark Shanghai stock index dropped by almost 7%. But investors quickly regained confidence when it became clear that the dip in Asia would not cause reverberations on the international equity markets. On the very same day, the US stock market in fact hit a new high.

There is a growing consensus that the US economy is through the worst. Admittedly, Q1 US growth was revised down from an already weak 1.3% to as little as 0.6%, but other indicators are giving the impression that growth might accelerate significantly in Q2. Consumer confidence has been surprisingly strong in May despite high gasoline prices, and the Chicago purchasing managers’ index rebounded, rising to a level of over 60. The minutes of the last Fed meeting, which were published this week, more or less confirmed the market’s assessment. The Fed too expects that growth will pick up in the coming quarters, approaching potential growth again. Thus inflation remains the FOMC’s predominant concern.

The mood in the euro area remained excellent. Consumer and business climate in the EMU improved, confirming the trend of the national data. German orders for machinery and industrial equipment, which had rocketed in the previous months, did correct significantly in May, but the industry remains confident and has raised its 2007 growth forecast from 4% to 9%. Moreover,
unemployment in Germany has declined further in May and is now the lowest in five-and-a-half years. Seasonally adjusted unemployment has risen slightly month-on-month, but this is due to the weaker than normal spring recovery after the very mild winter.

Given the favourable data, there is no doubt that the ECB will raise interest rates to 4% next week. The market assumes that there will be another one or two steps after that. ECB representatives have done nothing this week to dispel this impression. They are keeping all options open, which the market is reading as further tightening.

Axel Weber, president of the Bundesbank, this week voiced his dissatisfaction with the ECB’s key words. In his opinion, key words were useful in the phase of monetary policy normalization, but are now, at the end of this phase, more of a problem. He thus thinks that these words will disappear from the ECB statements at some point in the future.

It would be a big surprise if that already happened next week. Market participants are waiting with bated breath to see whether the ECB Council will still class the new interest rate level as accommodative. Since the 2007 and 2008 projections for growth are likely to be raised by 0.2 percentage points each, and for inflation by 0.1 percentage points each, the market does not expect the Council to change its monetary policy stance.

At first glance this is also supported by the still high monetary growth. In May, M3 once more grew by a double-digit rate at 10.3%, but compared to last month monetary growth has slowed down significantly. Growth of the most liquid components (M1) has levelled off in particular. As far as the M3 counterparts are concerned, lending to private households has slowed further. Therefore ECB president Trichet is unlikely to be overly critical of the monetary pillar at the press conference on Wednesday.

Compared to the current market expectations, the ECB is unlikely to sound very aggressive in its wording. Therefore the central bank meeting will not propel the euro upward.

Uwe Angenendt +49 69 718-3648

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.
© 2007 BHF-BANK Aktiengesellschaft
All rights reserved. Please mention source when quoting from it.


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