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Forex Market News - FX Briefing - ECB announcement irritates market participants

FX Briefing 24 August 2007

 

Highlights

·        Discount rate cut signals Fed is prepared to act

·        Steady stock markets support the euro – for now

·        ECB’s reference at August statement not intended as a monetary policy message

 

ECB announcement irritates market participants

This week equity and foreign exchange markets stabilised after the Fed’s discount rate cut. Compared to last Friday’s highs, the yen has dropped significantly. USD-JPY recovered to around 116, EUR-JPY to 157. EUR-USD strengthened slightly from 1.34 to just over 1.35.

 

Last Friday the Fed surprised the markets with a 50 basis points cut in the discount rate to 5.75%. Moreover, banks can now borrow money from the discount window (which is similar to the ECB’s marginal lending facility) for up to 30 days. The Fed in addition published a statement saying that the downside risk to growth has increased considerably because of the change in credit market conditions.

 

The Fed’s actions fuelled expectations for further US interest rate cuts. Temporarily, markets had priced in reductions by more than 75 basis points by the end of the year and at the beginning of the week there were rumours that a cut in the fed funds rate was imminent. When equity markets recovered in the course of the week, interest rate cut expectations subsided somewhat. But there is little doubt that the fed funds rate will be at least 50 basis points lower by the end of the year.

 

The ECB on the other hand had no further comment on the situation. Its massive early liquidity injections had given the impression that the central bank did not want to run any unnecessary risk in the current critical situation and that it would at least not go through with the interest rate hike originally envisioned for September. And markets initially showed little reaction to the Bundesbank’s rather hawkish Monthly Report, especially since the bailout of SachsenLB hit the news at the same time.

 

Market participants were irritated, however, when the ECB announced an additional 3-month refinancing operation with a volume of €40bn. The central bank pointed out that this was a technical measure, and with respect to its assessment of the monetary policy situation it said that ECB President Trichet’s statement from the beginning of August was still valid. Many market participants took this to be a confirmation of the ECB’s intention to still raise interest rates. As a result, 3- month interbank rates, which had already been elevated by hefty risk premiums, rose above 4.70%.

 

We think this interpretation of the ECB’s statement is exaggerated. Liquidity management decisions are taken by the ECB Directorate, while the ECB Council is responsible for the monetary policy assessment. In our opinion the reference to Trichet’s statement only means that the step is not connected with any monetary policy message.

 

So what to expect from the ECB meeting in September? Let’s stick to the facts: The disruptions in the money and credit markets are a lot more serious and pernicious than the ECB could have foreseen at the beginning of August. And if the risk premium in the European interbank market – gauged by the spread between 3-month money and a 3-month Eonia swap – widens continuously to over 50 basis points, this is no small matter. The deterioration in financing conditions is likely to hurt the real economy over a longer period.

 

Mr Trichet pointed out again and again at the press briefing on 2 August that the ECB Council would not precommit itself by using key words such as “strong vigilance“. And he moreover stressed that the ECB would be watching the development on the financial markets very closely. Under the current circumstances the ECB could easily justify holding interest rates. For this, it would not have to fundamentally change its view. We therefore still expect the ECB to leave the refi rate unchanged at 4% in September.

 

Next week a row of interesting data is due, such as the ifo business climate, the GfK consumer climate and the results of the EU Commission surveys. We expect the sentiment indicators to continue their downward trend of the past months; especially the expectation components are likely to have suffered. Against this background the euro might show some weakness.

 

Stephan Rieke +49 69 718-4114

Economics Department

+49 69 718-3642

volkswirtschaft@bhf-bank.com

Foreign Exchange Trading

devisenhandel@bhf-bank.com

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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