Nov. 20, 2006 — Euro strength and yen weakness are the main drivers in FX amid speculation that the Japanese government will downgrade the nation’s economic outlook for first time in two years, and renewed hawkishness by the European Central Bank (ECB) to combat inflation despite what it viewed as a temporary dip in consumer prices. The sterling joined the euro in dragging the dollar lower after house prices in the United Kingdom rose at the fastest pace in two years this month, fuelling speculation that the Bank of England may raise rates to 5.25% next month and match U.S. short-term rates for the first time in a year.
The official communiqué from this weekend’s Group of 20 meeting of central bankers and finance ministers stated that that inflation remains their immediate risk, opening the door for further rate hike expectations. The G20 reiterated that emerging markets need to pursue currency flexibility but did not single out any country, thus lifting attention from China, as has been the case in the last two G7 meetings. Comments of higher rates increase interest rates continue to provide a fresh boost for carry trade plays benefiting the high yielding USD, AUD and GBP at the expense of JPY and CHF.
This morning’s report (10:00 am EST ) on U.S. October index of leading economic indicators is expected to rise 0.2% after a similar increase in September thanks to gains in stocks and consumer confidence as well as positive readings in jobless claims.
U.S. Treasury Secretary Paulsen’s speech on U.S. capital market competitiveness at noon may tackle the topic of foreign demand for U.S. instruments and the financing of the U.S. trade gap. Several Fed officials –including Former Chairman Greenspan-have raised the question on the duration of such financing.
Yen hit by downgrade speculation The yen slumps across the board following reports from the weekend edition of Nihon Keizai Shimbun stating the nation’s growth outlook will be downgraded. This would be the first time the government lowers its assessment, thus, thus, slamming all hopes of a Bank of Japan tightening before year-end. In the event that these reports do materialize, the Japanese currency may sustain renewed selling towards the 118.60s against the dollar and test 152 against the euro.
USD/JPY eyes the 118.21 resistance –50% retracement of the 119.87-116.54 decline. An upside surprise from the US LEI index could extend gains to 118.40, with resistance seen holding at the 61.8% retracement of 118.60. Renewed support stands at 117.80—38% retracement of said move, followed by 117.50.
Euro revived by hawkish ECB Concerted hawkishness from the European Central Bank fuelled the euro despite last week’s sub-2.0% inflation headline from the Euro zone. ECB President Jean-Claude Trichet said falling oil prices remained a threat to inflation, warranting policy vigilance. ECB council member Nicholas Garganas said inflation risks have yet to be eliminated despite the five interest rate increases of the past year, adding that borrowing costs are still “historically low.” The comments not only confirm that the ECB will raise rates to 3.50% next month, but also suggest they could attain 4.00% by end of the first quarter.
Rising for the second straight day, EUR/USD approaches near-term resistance at 1.2870, but increased pressure stands at the 1.29 figure. Any figure below 0.1% in the US LEI report could call up 1.2930. Support starts at 1.2830, followed by 1.28.
Sterling boosted by fresh housing strength Sterling remains on the rise on hopes of further rate hikes by the Bank of England after a report showed house prices growing at their fastest pace in two years. Property prices increased 12.4% in the year ending in November according to Rightmove, the United Kingdom's largest real-estate Web site. The report follows last week’s survey from the Royal Institute of Chartered Surveyors showed home prices reached their four-year highs last month. Sterling is not only boosted by evidence of rising home prices and above 2.0% inflation, but is also sustained by strong demand as signaled by strong retail sales. Some Bank of England MPC members have expressed ambivalence with rising unemployment, but the price and growth data suggest that at least one more rate hike is in the making.
Unlike the Federal Reserve, which raised rates continuously between June 2004 and 2006, the Bank of England has had a more volatile monetary policy. The central bank raised rates five times between 2003 and 2004, before cutting rates to 4.50% in summer 2005. The central bank then reverted to tightening mode when it raised rates in August before following up this month with a 25-basis point hike to 5.00%.
Our call in last Thursday’s weekly research note indicating upside gains in GBP/JPY has been realized with a 100-pip gain from 223.00 to 224.00.
Cable nears the 1.90 figure—the 50% retracement of the 1.9176-1.8834 decline, which is followed by 1.9930. Support stands at 1.8930, backed by 1.89.
Ashraf Laidi Chief FX Analyst CMC Markets US 140 Broadway, 30th Floor New York, NY 10005 (212) 644-4220 (212) 644-4222 faxa.laidi@cmcmarkets.com
