Daily currency analysis
The Euro was unable to sustain a move above the 1.44 level on Wednesday and, after holding steady in early US trading, the Euro dipped sharply to lows around 1.4325 before recovering back to 1.4380. There has been further evidence of position adjustment with a reduction in excessive short dollar positions. This shift has tended to weaken the Euro with the impact magnified by reduced levels of liquidity.
There have been further sub-prime concerns over the day with a downgrading of two bond insurance firms and further debt write-downs by Morgan Stanley. Financial fears will maintain fears over the US economy, but will also increase concerns over the global growth and credit trends. These fears will offer some dollar protection, especially if there is a spate of international ratings downgrades.
The German IFO index weakened to 103.0 in December from 104.2 previously which will reinforce expectations of a significant slowdown in the economy with the IFO cautious over the outlook.
ECB member Liebscher warned that downside risks to growth were increasing, but the central bank comments were mixed as ECB president Trichet issued a tough statement on inflation. Any further sharp Euro retreat would increase the chances of an interest rate increase, although policy should remain firmly on hold in the short term.
The yen fluctuated either side of the 113.0 level against the dollar on Wednesday while strengthening to beyond 163.0 against the Euro.
The yen gained support on fears that sub-prime losses were spreading, especially after the ratings downgrade of bond insurers MBIA and Ambac Financial. These downgrades will increase fears over a further series of downgrades and a forced unwinding of leveraged positions which could strengthen the yen sharply.
The Bank of Japan downgraded its 2007/08 GDP growth forecast to 1.3% from 2.1% previously which will reinforce expectations that the Bank of Japan will not increase interest rates in the current fiscal year. The yen will, therefore, remain vulnerable on yield grounds and maintain the temptation to allocate funds overseas.
There has also been evidence of increased retail yen selling to invest in high-yield currencies and sustained buying of overseas assets would tend to weaken the yen, although caution is still liable to prevail given the market stresses.
Sterling consolidate in early Europe on Wednesday ahead of the MPC minutes, but then weakened sharply. The UK currency fell to lows near 0.72 against the Euro and also retreated steadily to a three-month low near 1.9950 against the US dollar.
The MPC minutes from the December meeting recorded a 9-0 vote for unchanged rates compared with expectations that there had been some votes against the rate cut. The bank expressed increased concerns over the growth risks stemming from tighter credit conditions, especially with confidence weakening, and these fears were deemed to be more important the underlying inflation fears.
The Swiss franc had a slightly firmer net tone against the Euro on Wednesday, although it struggled to make strong headway while the dollar challenged the 1.1580 level against the franc before correcting weaker.
Short-term Swiss franc moves will still tend to be dominated by levels of risk aversion. Underlying fears over sub-prime risks will support the franc at times, but volatility will be a feature with the global central bank efforts at boosting liquidity undermining the currency at times
National Bank member Jordan warned that the bank would take action if franc weakness put upward pressure on inflation and the consumer inflation data will be watched closely on Thursday.
The Australian dollar has secured a slightly firmer tone in local trading on Friday, but was unable to make a challenge on the 0.8650 level against the US currency.
The Australian dollar is gaining support from yield expectations with markets pricing in around a 40% chance of a February interest rate increase, although these expectations are liable to be scaled back over the next few weeks as credit fears persist. Despite evidence of investment inflows into Australia from Japan, investors overall are still likely to be cautious and the Australian dollar weakened back below 0.86 in US trade.