ECB in state of heightened alert (page 1 of 2)

DailyFX Fundamentals 06-10-08

By Kathy Lien, Chief Strategist of DailyFX.com

How much higher can the US Dollar rise?

So far it has been a very good week for the US dollar, which has seen its biggest two day rise in three years.

In fact, against every major currency except for the Euro and Swiss franc, the greenback has erased all of last week's losses.

Last night, in an exclusive interview with The Times of London, US President George W Bush joined the chorus of government officials calling for a stronger dollar.

With no ambiguity in his words, Bush said 'we want the dollar to strengthen.'

This followed comments by Ben Bernanke who reminded the markets last night that inflation is the central bank's top priority.

According to the Fed chairman, the FOMC will 'strongly resist an erosion of longer-term inflation expectations, as an unanchoring of those expectations would be destabilising for growth as well as for inflation.'

Bernanke even went so far as to say that despite the fact that the unemployment rate jumped from 5% to 5.5%, the US economy has skirted a major decline.

If you recall yesterday afternoon, US Treasury Secretary Paulson also said that he would not rule out any policy tool including currency intervention.

This clear and cohesive message reflects the seriousness of the Bush Administration and their strong desire to see the dollar rise (Will the Bush Administration Actually Intervene in the US Dollar?).

As a direct result of these recent comments, currency traders have sent the US dollar higher for the second day in a row.

Since the beginning of this week, the US dollar has already appreciated 300 pips against the Japanese Yen and close to 400 pips against the Euro.

How much higher the US dollar will rise will be largely dependent upon this week's retail sales report as well as this weekend's G7/G8 meeting. With the labour market deteriorating, if higher gasoline receipts exceed slower spending on other discretionary goods, retail sales could beat expectations.

Over the past 30 years, G7/G8 meetings have marked major turning points for the US dollar. Even though only Finance Ministers will be attending the meeting in Japan, intervention could still happen.

The US government already supports a stronger dollar, which means that half of the battle for verbal intervention may have already been won. However, it is the Europeans that need to be convinced. With the ECB on a mission to do all that it takes to lower inflation, they may not be willing to let the Euro weaken.

ECB in a state of heightened alert

Although the Euro has plunged close to 400 pips as the currency market turned its focus to the comments made by US officials, traders should not lose sight of hawkish comments that have also been made by the European Central Bank.

According to ECB member Erkki Liikanen, the central bank is in a state of heightened alert. Along with central bank members Liebscher and Noyer, Liikanen stressed the need to contain inflationary pressures and how the rise in prices is making their jobs increasingly difficult.

Unsurprisingly, German wholesale prices increased more than expected last month while industrial production beat expectations in France and Italy.

Growth in the Eurozone has been steady, which is part of the reason why the ECB has felt comfortable enough to be exceedingly hawkish.