Warnings from the ECB Weigh on Euro (page 1 of 2)

DailyFX Fundamentals 02-20-08

By Kathy Lien, Chief Strategist of DailyFX.com


Not Good Enough for the US Dollar

It has been a very active trading day with market moving news coming from all four corners of the forex market. The US dollar was firm ahead of the NY open but reversed all of its gains by the end of the US session. The only two currencies that failed to rally against the US dollar were the lowest yielding ones which are the Japanese Yen and Swiss Franc. Although consumer prices and housing numbers were stronger than expected, the dollar's knee jerk rally quickly evaporated as the market realized that inflation was not hot enough for the Federal Reserve to reconsider their intentions of lowering interest rates. This belief was validated by the minutes from the last FOMC meeting where the Fed cut interest rates by 50bp. At the meeting, the US central bank reduced their growth forecasts and increased their forecasts for inflation and unemployment. By the end of the year, they expect the unemployment rate to rise to as high as 5.3 percent. A pessimistic tone hung over the meeting with several members noting significant risks of a downturn in the economy. They felt that the combination of sharp equity market weakness and declining house prices would crimp consumer spending going forward. As a result, interest rates are expected to remain low for some time to "counter the factors that were restraining economic growth, including the slide in housing activity and prices, the tightening in credit availability, and the drop in equity prices." Fed fund futures continue to price in a 94 percent chance that interest rates will be cut by another 50bp in March. Although it is too soon to be worried about this, it is important to not forget the Fed's warning today that should the economy stabilize and prospects for growth improve, a "rapid reversal" of a portion of the previous easing actions may be appropriate. Housing starts rebounded but building permits fell another 3 percent to the lowest level in 16 years. Leading indicators, jobless claims and the Philly Fed survey are due for release tomorrow. We expect the dollar to continue to remain weak because consumer prices was the only release this week that had the potential to trigger a reversal in the US dollar and unfortunately the impact was minimal.

British Pound Tanks As BoE Minutes Reveal Unanimous Support for a Rate Cut

So far this week, one of the best trades in currency market has been to sell British pounds. The nationalization of Northern Rock as well as the surprisingly dovish minutes from the Bank of England's latest monetary policy meeting has pushed the GBP/USD within 50 pips of its 12 month low. Last week, the Bank of England released a relatively hawkish Quarterly Inflation Report, where they warned that inflation could breach the government's 3 percent limit this year. This led many people to believe that the decision to cut interest rates earlier this month would meet resistance. However to the market's surprise, not only did every single member of the MPC vote in favor of cutting interest rates, Blanchflower actually voted to cut rates by 50bp instead of 25. According to MPC member Barker, the slowdown in the economy is more worrisome than rising inflation. Another 50bp of easing has already been priced into the futures market and there is a decent chance that rates will fall to 4.25 percent before the BoE is done. Retail sales are due for release tomorrow and we expect the strength of the labor market to drive up spending

Warnings from the ECB Weigh on Euro

With every passing day, the European Central Bank is slowly shifting its tone.