Iraq dominates the currency markets

Euro

The week began with markets focused on the release of the U.N. weapons inspectors report to the Security Council on Baghdad's compliance with demands outlined in a tough council resolution.

Chief inspector Hans Blix told the Security Council that Iraq had provided access to weapons sites only grudgingly and that Iraqi President Saddam Hussein had also failed to fill gaps in information about Iraq's past programmes on weapons of mass destruction.

Market participants saw his remarks as increasing America's determination to take military action to oust Saddam's regime. Euro/dollar tested a 3-year high of 1.0907 before retreating on nervousness about possible intervention after Bundesbank President Ernst Welteke said it would be a worrying sign if the dollar fell too quickly against the euro.

As fears of intervention loomed in the financial markets, euro/dollar failed to get much of a lift after Germany's key Ifo business sentiment indicator rose for the first time in eight months to 87.4 in January. The dollar also received mild support from a smaller-than-expected fall in U.S. consumer confidence in January and a hefty rise in new home sales for December.

Midweek, the euro again tested the $1.0899 level in reaction to President Bush's State of the Union address. The U.S. led war with Iraq seemed to draw closer after President Bush said, "crucial hours may lie ahead" for U.S. troops in the Gulf. Bush made it clear that the U.S. was prepared to act to disarm Iraq with or without U.N. backing.

However, the euro backtracked after fresh comments from Ernst Welteke who said the rapid pace of the euro's rise in value against the dollar would pose a problem for the euro zone economy if it continued.

The greenback also found some reprieve as worries about the U.S. economy were soothed a bit after the Federal Reserve, at the end of its two day monetary policy setting meeting, maintained that the risks to the economy were finely balanced between downturn and inflation.

The Fed kept interest rates unchanged at 1.25 pct. There was a sense of relief as some analysts had thought the Fed might be more pessimistic about the economy and state the balance of risk had again shifted towards weakness.

The Fed's uplifting message and renewed hopes that Washington will not have to go to war alone if it sought to disarm Iraq by force, prompted investors to buy back some dollars. Fears that the U.S. would not have to foot the hefty war bill alone subsided on Thursday, after leaders of eight European nations published a letter of support for Bush in the Wall Street Journal.

The leaders called on the peace camp, implicitly Germany, France and Russia, to rally to the U.S. stand against Iraq. The U.S. unit gained a psychological foothold and the euro fell as low as $1.0733. The dollar's gains unravelled later in the day after advance fourth quarter gross domestic product (GDP) figures indicated tepid growth.

The U.S. economy expanded only 0.7 pct versus the buoyant 4.0 pct leap in the previous quarter. Additionally, a massive fourth quarter loss posted by AOL Time Warner also demoralized Wall Street and the dollar. The Dow Jones Industrial Average closed below 8000 for the first time since October.

Going into the last trading day, data showing the U.S. manufacturing sector expanded in January and signs of strength in U.S. consumer spending, momentarily deviated market's attention from the U.S. - Iraq developments, and helped buoy the dollar to 1.0725 level against the euro. The regional Chicago Purchasing Managers Index (PMI) rose to 56.0 in January, well above the consensus estimate of 52.6.

Additionally, consumers continued to spend at a healthy pace in December. Personal spending climbed 0.9% following a revised 0.4% gain in November, highlighting the resilience of households amid the lacklustre performance of equities and anxieties over an impending war with Iraq. Meanwhile, the University of Michigan's consumer sentiment report pointed to flagging confidence in the beginning of the year.

The index slid to 82.4 in January from 86.7 in December. The data however, failed to put much of a drag on the greenback as euro zone consumer sentiment data released earlier showed morale fell for the fourth month running to hit its lowest level since 1997.

Meanwhile, at Camp David, Tony Blair, Britain's prime minister, gave the firmest indication yet that he believes war with Iraq is inevitable, warning that he thought Saddam Hussein, Iraq's leader, would not surrender his weapons of mass destruction.

The coming week also holds plenty of data releases and euro is likely to continue its roller-coaster ride against the dollar.

Range for the week: $1.0650 - $1.1050

Japanese Yen

Dollar/yen experienced wild gyrations in the course of the week, as U.S.- Iraq war rhetoric pulled the dollar lower and intervention talk by Japanese officials pushed the U.S. unit higher.

Having tested a low of 117.55 at the beginning of the week, the currency pair touched levels of 120.07 on the last trading day following the release of better-than-expected U.S. manufacturing data and confirmation of intervention rumors by Japan's Ministry of Finance.

An admission by Japanese monetary authorities that they had covertly intervened in the foreign exchange market on numerous occasions in January encouraged traders to sell the yen. Japanese officials conceded that they had in fact used "pre-emptive" measures aimed at stabilising the yen, but were not seeking to weaken the currency.

The MoF described undesirable fluctuations arising from geopolitical risks that the Japanese government needed to address as the reason, and said its intervention was a little less than $6 billion. The MoF admitted to the first selling action under Japan's recently appointed financial diplomat Zembei Mizoguchi who succeeded Haruhiko Kuroda on January 14.

Meanwhile, data reported earlier showed that the economic landscape in Japan remains bleak. The December unemployment rate matched its post-war high at 5.5% compared to a month ago at 5.3%. Unemployment for 2002 was 5.4% seasonally adjusted, up considerably from 5.0% in 2001.

Range for the week: 117.50 - 121.50

Sterling

With financial markets seemingly daunted into buying up euro, swiss franc and yen due to fears of intervention, investors turned their eyes to the sterling.

The pound turned out to be the flavour of the week, as it tested new highs against the beleaguered dollar on a daily basis. Analysts also attributed a lot of the pound's buoyancy to technical factors, including profit-taking and stop-loss trades on the euro/sterling currency pair which hit a 3-1/2 year high last week.

Sterling climbed to a fresh 3-year high of $1.6569 on the last trading day of the week, helped by solid consumer data reported in the previous day's trading session. The Nationwide Building Society said British house prices rose another 1.7 percent this month, taking the annual rate of increase to its highest since 1989.

Additionally data from the Bank of England (BoE) showed Britons' appetite for debt showed no signs of abating last month with net consumer credit rising by a higher than expected 1.917 billion pounds. Sterling later gave up ground to close at the $1.6488 level in the face of strong manufacturing data from the U.S.

Range for the week: $1.6250 - $1.6700