â€˘ Japanese Yen: Continues rangebound
â€˘ Euro: Drifts lower as inflation tame
â€˘ Pound: PMI Construction less than forecast bust
â€˘ USD: Pending Homes on tap
Euro Drops Below 1.42 on Doubts of Further Hikes From ECB
The EURUSD traded below the 1.4200 figure in early European trade today as muted inflation readings and the prospect of the end of ECB tightening cycle weighed on the pair. As we examined in our Special Report the notion that 4% may be the end for Euro-zone rate hikes is beginning to give some traders pause regarding further upside potential in the pair.
Tonightâ€™s economic news only accentuated those doubts as Eurozone PPI readings offered no evidence of price pressures in the region. The PPI data printed softer than expected at 1.7% on a year over year basis versus 1.8% forecast. The PPI result was the lowest reading in three years as the higher exchange rate of the EURUSD offset the rising effects of commodities, most of which are priced in US dollars.
With producer inflation well below the ECBâ€™s own 2% target rate, there is little reason for the central bank to consider another rate hike in the near future. The higher EURUSD is essentially acting as a deflationary force in the economy performing the monetary authoritiesâ€™ task of price stability for them. As we stated yesterday, â€śGiven this dynamic the ECB is unlikely to adopt a particularly hawkish posture at its monthly rate announcement meeting this Thursday. While President Trichet as always will refuse to precommit to any specific course of action, the net result of the combination of rising euro and slowing economic growth in the Eurozone should keep the ECB stationary for the rest of 2007.â€ť
Recent trading in the EURUSD has been reflecting these concerns, as the pair failed to make new highs in yesterdayâ€™s New York session despite a strong rally in equities that took the Dow above 14,000 on a closing basis for the first time ever. Although risk appetite was rampant in the financial markets little of it translated into carry trade buying of EURJPY and that in turn failed to lift the EURUSD. If the ECB does indeed stop this cycle at 4%, euroâ€™s role as a carry currency will be greatly diminished. Although the euro yield remains a respectable 4%, in the FX markets it is the anticipation of future rate hikes that drives price action. With interest rates likely capped at the current levels, the euro may revert to its familiar dynamic of trading as the anti-dollar and unless US economic data shows marked deterioration, further gains in the pair may be limited for the time being.