Sunday, January 24, 2010

FX Briefing : Dollar Remains Firm

  • Markets are still sceptical about the Greek savings plans
  • UK inflation accelerates markedly, but BoE governor Mervyn King seeks to reassure
  • Strong GDP growth in China increases likelihood of monetary policy tightening
  • US president Obama wants to impose massive restrictions on banks' activities
  • FOMC could turn slightly more hawkish

The dollar remained firm for the most part this week. EUR-USD fell to a 6-month low of 1.4029 on Thursday, before recovering again somewhat on Friday to around 1.41. The movement is mainly a result of inherent weakness in the eurozone. A disappointing ZEW index, guarded comments on the economy from ECB members, and the constant discussions among market participants about Greece's debt crisis and its potential consequences for the currency union and the EU are all spreading doom and gloom.

UK consumer price data also had a significant impact on the forex market. UK inflation accelerated from 1.9 to 2.9% in December, reflecting the renewed rise in energy prices on the one hand and the base effect of the VAT cut in December 2008 on the other. Some retailers are likely to have already raised prices ahead of the return to normal VAT rates in January, which probably also played a part. Prices have increased much more sharply than predicted in the BoE's November Inflation Report, however. Given the VAT hike in January, the inflation rate is set to rise well over 3%.

The inflation figures are prompting speculation as to whether the Bank of England could start tightening monetary policy sooner than expected. The pound also strengthened on the back of the assumption that it would benefit from the Greek crisis. EUR-GBP dropped around 3 pence temporarily to 0.8650; cable rose to a peak of 1.6460. By forecasting that the inflation rate would return to the 2% target again in the medium term, the BoE governor Mervyn King at least put paid to speculation on interest rate hikes for the time being, as there would then be no immediate need for the BoE to take monetary policy action. There is not much news about Greece. At the beginning of the week, EU finance ministers discussed the problem. Their comments on the Greek savings plans were somewhat restrained. The Greek government is trying hard to build up confidence. Meanwhile, spreads between Greek government bonds and Bunds have widened to new record highs. The developments in the markets appear to be somewhat exaggerated, but there is little hope of the situation calming down in the near future.

This week, the dollar received indirect support from China. Firstly, the government in Beijing reported strong GDP growth of 10.7% in Q4 . Secondly, several official spokesmen omitted the customary reference to maintaining a “moderately loose monetary policy”. Observers interpreted this as a sign that the People's Bank of China is planning further measures to tighten monetary policy.

US economic data did not have much impact this week. The figures published continued to confirm the guardedly upbeat assessment. Then, towards the end of the week, President Obama dropped a bombshell: in a short, tough speech, he outlined his plans to reform the banking system. Firstly, he proposes to restrict banks' business activities: they would no longer be allowed to own, invest in or sponsor hedge funds, private equity funds or proprietary trading operations for their own profit unrelated to serving their customers. His second aim is to limit the size of banks, by restricting market shares for deposits, for example. If these proposals are implemented, they will place massive restrictions on banks' activities.

Next week, the focus will be on the FOMC meeting. Given the positive trend in Q4, we are expecting the central bank to raise its economic assessment again slightly. It could also modify the statement that the economic situation warrants keeping central bank rates at exceptionally low levels for an extended period.

This report has been prepared by BHF-BANK Aktiengesellschaft on behalf of itself and its affiliated companies (together "BHFBANK Group") solely for the information of its clients.

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