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Friday October 5, 2007 - 14:19:03 GMT
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FX Briefing 5 October 2007


·        Strong equities and a more favourable US labour market outlook support dollar

·        ECB moves further away from planned interest rate hikes

·        ECB monetary policy no longer accommodative

·        Danger of EU’s ambitious G7 aims backfiring


 ECB treads cautiously

During the course of the week, the dollar managed to recover somewhat. In view of the surprising rally on equity markets and relatively upbeat expectations for the US labour market in September, some market participants are becoming a little more cautious in their forecasts for Fed rate cuts. Just before the release of labour market data, EUR-USD was trading above 1.41. The dollar firmed most significantly against the yen: USD-JPY rose to 116.60, EUR-JPY to 164.60. Most of the other major currencies also weakened somewhat against the US currency. Only a few Asian currencies made minor gains.


ECB and BoE central bankers, who held their regular meetings this week, left interest rates on hold. Some market players who had been secretly hoping that the BoE would complete its transformation from a hawk to a dove by cutting interest rates already, were disappointed. The ECB confirmed its assessment that medium-term risks to price stability persist. However, despite the current acceleration of inflation, it still stuck to its 2% forecast for 2008. ECB president Jean- Claude Trichet also pointed out that the underlying momentum is actually less dynamic than the

money and credit growth rates suggest.


he ECB is still sticking to its optimistic assessment of economic growth prospects. However, growth risks, particularly for 2008, are being emphasized more. Now, in addition to the tighter financing conditions, the ECB’s list of risks also includes negative consequences for economic confidence and possible disorderly developments owing to global imbalances. In the two latter points, the ECB is apparently referring to the deterioration in business and consumer sentiment and to the rapid appreciation of the euro.


Indeed there are more and more signs that the European economy is losing momentum. According to the European Commission’s latest quarterly report for the eurozone, the economy appears to have passed its cyclical peak. In this connection, the report points out that residential construction activity has weakened, global trade growth has slowed down somewhat, and that many confidence indicators have deteriorated. The Commission pointed out that these developments were not connected to the current financial market problems. It is using simulation models to try to quantify the possible consequences of the tighter financing conditions. According to these, an average rise in risk premiums by 50 basis points in the eurozone and the US could reduce growth by 0.3 percentage points.


The latest ECB Bank Lending Survey also reveals more restrictive conditions that are likely to dampen growth. In the third quarter, credit conditions especially for corporate loans tightened significantly. This affected large companies and long-term financing in particular. Margins were raised across the board, especially on riskier loans; but conditions have generally become more restrictive with respect to volume, collateral, maturities and other clauses. Conditions on loans to private households were not tightened as drastically, and affected mainly mortgage loans. Due to intense competition and lower demand, banks mainly tightened conditions here via higher requirements for collateral.


For the first time for ages, the ECB statement did not describe monetary policy as accommodative. This is a sign that the central bank does not see any necessity to raise interests rates at the moment – partly because of increased growth risks and partly, because, due to sustained money market tension and the appreciation of the euro, monetary conditions have become significantly tighter than the refi rate target suggests.


European preparations for G7

In his comments on exchange rate developments in the last few weeks, ECB president Jean-Claude Trichet had always reverted to the position formulated by G7 finance ministers and central bankers at their last meeting in Essen. However, the use of the phrase “possible disorderly developments” in connection with global imbalances in the latest statement indicates that the ECB is not exactly happy about the rapid appreciation ofthe euro over the last few weeks. The words chosen sound a bit like “disorderly conditions”, a phrase which signals the need for the G7 to take action.


At present Europeans are attempting to agree on a common monetary policy stance for the G7 meeting on 19 October in Washington. To this end, representatives of the Eurogroup are meeting on Monday, and an Ecofin Council meeting is being held on Tuesday. The fact that French president Nicolas Sarkozy is attempting to shape monetary and exchange rate policy, is not making it any easier to achieve agreement. This is proving far from popular with the other EU countries and the ECB in particular. The ECB will on principle fight against any attempt to exert influence on monetary policy via exchange rate policy.


As far as the appreciation of the euro is concerned, the European countries’ positions do not diverge that much. At least within the EMU there is likely to be agreement that a further euro appreciation against the dollar is unwanted and that the euro is fundamentally overvalued against the yen and the renminbi.


However, the question is whether the US would be prepared to agree to this. The US Treasury Secretary has not recently given much indication of supporting a strong dollar; the US have been concentrating on exerting political pressure on China, and has made a point of not criticizing Japan, despite its massive current account surplus.


In the run-up to the G7 meeting, there is likely to be much speculation as to how much support Europe will get from the US. If the G7 closed ranks behind the concept of a strong dollar, this would be a real success; Europe would also welcome any demands for a reduction of the Japanese contribution to the global imbalances. However, if the US do not support Europe, things could get dangerous. No comment from the US on the appreciation of EUR-USD could easily be taken as consent.


Stephan Rieke +49 69 718-4114

Economics Department

+49 69 718-3642

volks[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.

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