Highlights
- Dollar boosted by weak economic data worldwide
- ECB considering further interest rate cuts, but still sceptical about zero rates
- Inflation rate in the eurozone drops more sharply than expected
USD: Strength Through Weakness
At the beginning of the week, equity markets recovered slightly from the previous week's lows. This was partly due to a few more positive reports from the corporate sector, and plans to recapitalise some financial companies, but the prospect of the US economic stimulus package and the impending FOMC meeting probably also played a part. On the currency markets, where last week increasing safe-haven demand had boosted the dollar and the yen, the euro, the pound sterling and other European currencies gained ground initially. Towards the middle of the week, EUR-USD climbed over 1.33 at times; USD-JPY, for its part, firmed to over 90. This counter-movement did not last long, however. Given the disappointing economic data and the prospect of dismal Q4 GDP figures on Friday, the dollar and the yen strengthened again to around 1.28 and just under 90 respectively.
EUR-CHF dropped below 1.49, after SNB president Jean-Pierre Roth made some relatively laidback comments on the franc's appreciation. The pound, which had plummeted the previous week, staged a significant recovery. GBP-USD rose by around 6 cents to 1.42, whereas EUR-GBP fell from 0.94 to about 0.90. The New Zealand dollar, on the other hand, took quite a battering: not only did the central bank cut interest rates much more drastically than expected (by 150 basis points to 3.50%), but it also hinted that further interest rate cuts were likely. NZD-USD dropped from 0.53 to 0.51.
Weak economic data
US economic data released this week were weak for the most part. Existing Home Sales brought a tiny glimmer of hope at the beginning of the week, posting a significant increase, albeit after having plunged to a record low in November. However, these were followed later in the week by some extremely weak figures. Consumer confidence fell to an all-time low of 38.6 in January; in December, durable goods orders posted a bigger- than-expected drop of 2.6% month-onmonth, and furthermore, the reading for November was revised down markedly. Last week, initial jobless claims were at just under 590,000 again, which bodes ill for the January labour market report.
Economic data from other countries were not much better either. In Japan, industrial production plummeted again by almost 10% compared to the previous month. In the fourth quarter, production fell by an average of 11.9%; moreover, at the end of Q4, production was already 9.5% below the average level for Q4 again, which does not bode well for the first quarter. In addition to this, a sharp turnaround seems to be taking place in the Japanese labour market: in December, the unemployment rate rose from 3.9 to 4.4%.
In the eurozone, things are still looking bleak too. Admittedly, the ifo business climate did improve slightly in January, from 82.7 to 83.0. However, one shouldn't read too much into this: at the current level, stabilisation only means that the economic downward movement is no longer accelerating. It should also be borne in mind that business expectations are responsible for the improvement in the business climate. The retail trade, the construction industry and part of the manufacturing sector are apparently hoping that the German government's economic stimulus package will provide fresh impetus.
Downside risks to price stability in the EMU
At next Thursday's meeting, the ECB governing council is likely to discuss the latest inflation and monetary developments. In January, inflation slowed down significantly again. According to Eurostat's flash estimate, the inflation rate fell from 1.6 to 1.1%. A detailed breakdown of the figures is not yet available, but, in our view, this is not likely to have been due to energy products alone. In the past months, prices for the important core products in the basket of goods had already started falling. Against this backdrop, the ECB is likely to find it increasingly difficult to maintain its assessment of balanced price risks. We ourselves see the inflation rate nearer to 1 than 2% in 2010.
The crisis has had a significant impact on monetary data too. In November and December, money supply growth practically came to a standstill, the previous year's rate declined to 7.3%. The fall in book credit is even more pronounced: up until September, the figures had been relatively normal; but since October, lending has virtually come to a halt.
In the last few days, ECB president Jean-Claude Trichet has once again signalled that there will be a thorough review of monetary policy stance in March. Neither an interest rate cut nor any great change in monetary policy assessment are likely at next Thursday's meeting. Nevertheless, the position appears to be changing in the council: initially, ECB representatives had hinted that there was less scope for interest rate cuts below 2%; now President Trichet himself is indicating that the ECB is not at the moment considering "very, very low interest rates" or "zero interest rates".
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