Daily currency analysis
The dollar held a firm tone on Thursday ahead of the ECB meeting, but was unable to sustain a brief move below 1.4650 against the Euro. Thereafter, the US currency weakened sharply as there were contrasting remarks from Federal Reserve and ECB officials.
As expected, the ECB left interest rates on hold at 4.00% following the latest council meeting. In a statement following the decision, ECB president Trichet stated that inflation pressures remained strong and that the bank would act pre-emptively on inflation. The central bank head stated that there had been a discussion of a rate hike at the meeting, although Trichet also warned that there were downward risks to the growth outlook.
The tough rhetoric is aimed to a large extent at domestic policymakers, especially as Trichet warned over wage trends. The ECB’s key concern is to prevent secondary inflationary effects from rising wage settlements. Nevertheless, the tough stance will provide important near-term Euro support.
In contrast, US Federal Reserve Chairman Bernanke, stated that further interest rate cuts may be required while the central bank was ready to take substantive action if required. The comments will reinforce market expectations that the Fed will sanction a 0.50% rate cut in late January which will tend to undermine the dollar in the short term. Some caution is required as there are a wide range of views within the Fed and there could be strong opposition to a 0.50% cut. Hoenig, for example, was more cautious over the need for further rate cuts, although he will not be a voting member.
The latest US jobless claims data recorded a drop to 322,000 in the latest week from 340,000 previously. The data will offer some degree of reassurance over the labour market, but recession fears will persist..
The dollar failed to gold above the 110.0 level against the Japanese currency on Thursday and weakened back to 109.30 in US trading, although the moves were relatively constrained in comparison to European currencies.
Bank of Japan Deputy Governor Muto stated that there were downside risks to the Japanese economy and, despite calls for a gradual tightening of monetary policy, the remarks did not suggest that this was a near-term possibility. The yen will, therefore, remain vulnerable to capital outflows if global risk conditions stabilise.
Wall Street was able to secure net gains after Bernanke’s comments and this curbed any buying pressure on the Japanese currency with the yen around 109.50 against the dollar.
Sterling found support close to 1.9550 against the dollar on Thursday, but was unable to regain the 1.9660 level. The UK currency also weakened to fresh all-time lows beyond 0.7520 against the Euro before a late rebound.
Following the latest Bank of England meeting, the MPC left interest rates at 5.50%. There was no statement with the decision and the breakdown of the vote will not be known until the minutes are released in two week’s time.
Sterling rallied briefly following the decision before being subjected to renewed losses. Although interest rates were held this month, there are strong expectations that the bank will cut interest rates in February. Markets are also expecting a series of rate cuts during 2008 which will undermine Sterling.
The headline trade deficit was at GBP7.4bn in November, unchanged from a revised GBP7.4bn the previous month which will not have a significant near-term impact. There will be some confidence over export trends following Sterling’s decline.
The Swiss franc retained a strong tone on Thursday and strengthened to test highs beyond 1.63 against the Euro. The franc also strengthened to test highs near 1.10 against the US dollar before retreating to 1.1040
There was sustained demand for the Swiss currency during the day with investors generally cautious over global risk conditions. The currency retreated from its best levels as Wall Street rallied, but the overall performance was still robust.
The Australian dollar held support close to the 0.88 level against the US dollar on Thursday and pushed sharply higher in US trading with a peak above 0.8950.
Domestically, the trade deficit fell to AUD2.25bn in November from a record deficit above AUD3.0bn previously as exports recovered. Domestic factors remained supportive with continuing speculation over a February interest rate increase while the aggressive comments from Fed Chairman Bernanke reinforced the Australian dollar’s yield appeal. Nevertheless, there are still important currency risks from increased unease over the global economy.