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Friday August 3, 2007 - 17:25:56 GMT
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FX Briefing 3 August 2007


·        ECB is carefully monitoring shift in risk assessment

·        ECB has signalled rate hike in September, but has not committed itself further

·        FOMC unlikely to change its position much


Forex markets hold their breath

On the surface, the forex markets seem to have calmed down again. Towards the end of the week, EUR-USD was around 1.37, slightly higher than a week ago. After last week’s sharp correction, the yen has fallen somewhat against most major currencies. Having ventured below 118, USD-JPY has firmed to 119; EUR-JPY has climbed above 163. Similar corrections are evident in all major currencies, but they are particularly striking in the American currencies CAD, MXP and BRL, as well as in the Norwegian krone.


However, appearances could be deceptive. Despite virtual exchange rate stability, the yen’s implied volatility has almost reached the highest level this year. Volatility reflects market participants’ risk perception, and the yen is the main funding currency for carry trades. Thus at the moment yen volatility can be seen as a sort of gauge of (declining) risk appetite on the forex markets.


Events on equity and credit markets are continuing to influence the forex markets; this week there was a rollercoaster of positive and negative news. Companies’ quarterly reports had a fairly positive impact on equity markets, but the subprime crisis claimed further victims, including a big US mortgage lender, a German bank and some funds.


ECB calls surprise press conference

The ECB Council’s August meeting, which was conducted by telephone, as is customary in the holiday season, still managed to surprise markets, albeit in a matter of form rather than substance On the day of the meeting, a press conference was called unexpectedly at lunch time. However, not with live coverage as usual, but as a closed session. The short notice and the unusual procedure caused speculation to run riot.


However, there were no surprises in the actual outcome of the meeting. In a short press briefing, ECB President Jean-Claude Trichet confirmed expectations that economic growth will continue in the eurozone, and said that rising oil prices, emerging capacity constraints and the potential for stronger wage and cost dynamics implied upside risks to price stability. This was also confirmed by the strength of monetary expansion. “Strong vigilance” was therefore essential to maintain price stability.


In his statement, Mr Trichet also mentioned the current nervousness in financial markets. In the ECB’s view, this is a normalization process after a phase in which risk has been underestimated. However, this development would have to be carefully monitored; it was important for investors, market participants and authorities to remain calm to allow the adjustment to take place smoothly.


The fact that the ECB used the phrase “strong vigilance” is confirmation of its intention to raise interest rates to 4.25% in September. At the same time, Mr Trichet refused to comment on what would happen after September. That could indicate that the ECB could be contemplating ending its tightening cycle. Furthermore, Mr Trichet’s remarks on financial market developments show some concern that the adjustment process could get out of control. That would be another reason for a cautious interest rate policy.


US economic situation before Fed meeting

After a very weak first quarter, Q2 growth was 3.4% (quarter-on-quarter, annualised), which was very encouraging. Exports and commercial construction made particularly strong contributions. This development is unlikely to be repeated on the same scale in the second half of the year. Therefore growth in the forthcoming quarters could turn out to be significantly lower – well below 3 per cent.


The momentum in the manufacturing sector seems to be slowing down. In July, the ISM manufacturing index dropped from 56 to 53.8, industrial new orders declined excluding the volatile transport component. Real consumer spending also levelled off in June. Nevertheless, consumer confidence has actually improved, and labour market data show that new jobs are still being created, despite the low unemployment rate.


The Federal Open Market Committee, which is meeting next Tuesday, is likely for the most part to stick to the position set out by Fed chairman Ben Bernanke when testifying to Congress. Although there is now more likelihood of a rate cut in the medium term, it is not yet on the agenda. The FOMC statement will probably be very similar to the one made in June. The Fed will probably point out that growth has remained moderate despite the drag from the housing market, and that inflation is slowing down. However, at the same time, it is likely to emphasize that price stability is not sufficiently safeguarded, and that inflation risks still prevail in view of high capacity utilization.


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


<i>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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