Highlights
- ECB signals interest rate cut in March, keeps all options open
- Speculation pushes rouble to the tolerance limit; central bank set to cut lending
- Only limited scope for yen to depreciate despite drastic fall in GDP
Euro Remains Under Pressure
The forex markets have continued to follow the familiar pattern: on signs that the crisis is escalating, the yen firms against the dollar, and at the same time, the dollar strengthens against the euro, and vice versa. Towards the middle of the week, EUR-USD rose to over 1.30. This was presumably due to firmer equity markets because of some positive news from the corporate sector, and possibly also because of the BoJ's announcement that it was earmarking 1 trillion yen to purchase corporate shares. In the US, pending home sales rebounded, which probably also contributed to the favourable mood.
During the course of the week, however, the euro gave up its gains again: due to the ECB governing council meeting, weaker US economic indicators and concern about the US labour market figures, the euro fell to around 1.28. Speculation against the Russian rouble could have weighed on the euro too.
ECB Council is keeping its options open As had been announced in January, the ECB governing council left interest rates unchanged at 2% at its meeting on Thursday. However, it signalled quite plainly that an interest rate cut was likely in March, when the new staff projections were available. By referring to the current market expectations, ECB president Jean-Claude Trichet hinted at the press conference that rates would probably be cut by 50 basis points.
But what is perhaps even more significant, in our view, is that, in its statements on further monetary policy action, the ECB council is keeping all its options open – from zero interest rate policy to quantitative easing measures. It has not said anything concrete, but it is no longer ruling anything out either. If the economic situation continues to deteriorate, the ECB can thus be pragmatic.
The ECB council itself is expecting an "extended period of significant economic downturn" and points to "very negative" GDP growth in the fourth quarter. Thus the ECB seems to be approaching our estimate. We are expecting GDP to have fallen by 1.5% quarter-on-quarter in the eurozone in Q4, and by 1.8% in Germany. The European growth data will be published this coming Friday and could put pressure on the euro next week.
Rouble trouble
Since at least mid-December, the Russian rouble has been under significant pressure to depreciate. The central bank is trying to stabilise the rouble's exchange rate against a currency basket of US dollar (55%) and euro (45%). On 22 January, the central bank announced that it would stop the rouble from depreciating beyond 41 against this basket. The markets immediately started pushing the rouble to that limit. The rating agency Fitch helped a bit too by downgrading Russia's rating by one notch to BBB on Wednesday. For the last few days, the rouble basket has been just under 41. The central bank, which has lost about 1/3 of its $600bn reserves in the last 6 months, is probably intervening massively at the moment.
The Russian central bank is in a dilemma: on the one hand, the economy and the financial sector are in a difficult situation, because as a result of the international financial crisis and the plunge in commodity prices, foreign capital inflows have plummeted. Accordingly, the Russian central bank is trying to stabilise the financial sector with generous supplies of liquidity and keep corporate lending going. On the other hand, the central bank is thus nurturing speculation against its own currency: the banks are said to be using a large proportion of the central bank loans to speculate against the rouble – which apparently appears more lucrative to them at the moment than lending to Russian companies.
Given the extensive speculation, the Russian currency reserves are melting away rapidly. The central bank is not likely to just sit back and watch this happening. It could either give up the rouble's peg to the currency basket, in which case the rouble would probably depreciate significantly, or it could stop the speculation by means of monetary policy and administrative measures. A return to capital transaction controls is unlikely for political reasons. It is more likely that central bank lending will be drastically reduced, possibly in combination with increasing interest rates. At the moment, Moscow appears to be leaning more in this direction. We are therefore inclined to think that it will be possible to uphold the 41 mark for the time being.
USD-JPY: limited upward potential
During the course of the week, USD-JPY firmed somewhat from just under 90 to over 91. Remarkably, the yen's strength is in complete contrast to the fundamental state of the Japanese economy. Here Q4 is set to be the third negative quarter in a row. The GDP data, due to be published on 16 February, will probably show that macroeconomic performance contracted by around 3% quarter-on-quarter.
The national trade association sees exchange rate developments as being responsible for this to a large extent, as export revenues are falling a good deal faster than export volumes. It is demanding that the yen should be stopped from appreciating further. There are rumours that the Japanese government is considering intervening.
From a technical point of view, there are plenty of potential ways of weakening the yen: intervening against one's own currency is not a problem. However, politically, there is only limited scope for doing so: on the one hand, it must be borne in mind, that by most standards, the yen is not overvalued; its development over the past months is rather a correction of its having been significantly undervalued in the past years. Thus the Japanese government will probably find it difficult to get international support. This applies particularly to the US, where the new government has already adopted a position against the valuation of the yuan, and where, in view of the crisis, protectionist tendencies appear to be increasing. Furthermore, it must be assumed that Japanese investors and companies will take advantage of the yen's weak phases to unwind foreign investments (carry trades) or repatriate foreign revenues.
Against a background of dire growth data we are expecting USD-JPY to recover somewhat; the risk of intervention is likely to support this trend. On the whole, however, we only see limited upward potential.
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