Forexperts

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As expected the European Central Bank left interest rates unchanged at 4.0%. The ECB's views on inflation and growth were not significantly different from those stated at its last meeting on March 6. While the Fed had dissenters at its last meeting regarding its recent interest rate cut, the ECB Governing Council was unanimous in its decision to leave rates unchanged.

Inflation versus Recession

At this time the Fed and the ECB are fighting different battles. The ECB's mandate is to keep inflation in line with its target rate of 2.0 percent. The current rate of inflation is 3.5 percent. Like the Fed, its chief weapon is interest rates. Unlike the Fed, however, the ECB choose to keep interest rates relatively high at 4.0%. Trichet and the Governing Council of the ECB believe that there are upside risks if interest rates are cut. His biggest fear is a hike in wages triggered by higher food and energy prices. He is calling for wage moderation.

The Fed on the other hand has been lowering rates in an effort to prevent a recession. At the same time it has have not to fuel inflation. In addition, the Fed has had to provide enough liquidity to prevent a financial system failure.

Widening Interest Rates Drive the Markets

Fundamentals aside, it all comes down to the interest rate differential. The market is going to seek the highest return. As long as the spread between U.S. rates and Euro Zone rates continues to widen, the EURUSD will continue to trend higher. The same scenario is taking place in the EURGBP. The weakening U.K. economy is going to force the Bank of England to slash rates in an effort to stimulate growth. As this interest rate differential widens, the Euro gains over the Pound.

Although there are going to be short-term breaks in the Euro versus both the Dollar and the Pound, trading the long side is the right way to play the interest rate differential.

Excessive Volatility or a Trend?

In his comments, Trichet also expressed his concerns about excessive volatility in the exchange rate market. "I deplore the excessive volatility of exchange rates. I was concerned by the recent excessive moves," he said.

From a chart-watchers perspective, he may be confusing volatility with a trending market. The EURUSD has been trading in a normal higher-top, higher-bottom trend. Traders have committed to the long side because the fundamentals mentioned above have pointed them in that direction. There have not been excessive up and down swings which by most defines volatility.

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