US dollar recovers some ground

Economic data released in the US revealed a gloomy picture, while in the UK data spelt doom for Sterling, which looked lost for most part of the week. The euro struggled, but managed to put up a brave display as markets await the release of the German Ifo business sentiment index, that is likely to decide the currency's fate during the coming week.

Euro

The euro commenced the week on a fragile note under pressure from the previous week's dollar onslaught, due to receding fears of a U.S. led attack on Iraq. The euro traded as low as 1.0678 before stabilising at 1.0700 levels helped by a cloudy but promising outlook from the ECB President Wim Duisenberg in his testimony to the Economic and Monetary Affairs Committee of the European Parliament.

Duisenberg, who said the euro's current levels reflected economic fundamentals, also added that the threat of war with Iraq was dampening the economic prospects of the euro zone. Volumes in the FX markets remained thin at the start of the week due to a holiday in New York and traders were left direction-less due to the increasing opposition to the United States campaign to disarm Iraq.

As the week progressed, the euro came across renewed pressure after investors rushed and bought yen at a torrid pace in what analysts attributed to repatriation flows and a diminished chance of intervention by Japanese authorities.

Meanwhile, Germany's ZEW Institute said that its economic expectations indicator rose by 1 point to +15 in February providing some solace for the wounded euro although the think tank later said that growth in the euro zone's largest economy would remain weak during the second half of this year.

German Finance Minister Hans Eichel played down the idea of a deepening economic crisis but said that Germany would almost certainly be unable to keep its budget deficit below the EU's 3 percent of GDP target, if growth fell below 1 percent in 2003. He also added that if a war with Iraq should occur, exceptions could be made to EU budget rules - - the stability and growth pact - - put in place to support the euro currency.

Elsewhere, data showing euro zone industrial output slumped by 1.5 percent in December 2002, its sharpest drop on record also cast a shadow over the euro although a poor number had already been priced in.

Midweek, news that the US and Britain would introduce a new resolution seeking authorisation for war against Iraq and continued repatriation flows into Japan took some shine off the dollar allowing the euro to tread on stable ground above key chart support at 1.07.

Although the market witnessed an unexpected rise of 0.2 percent in US January housing starts, the dollar's fortunes were decided by fluctuations in the US-Iraqi standouts. As the dollar remained to be driven by geo-political issues, US Defence Secretary Donald Rumsfeld declared that the military build up in the Gulf region had reached a point where US and British forces stood ready to invade if the order was given.

Also adding to the dollar's problems were a set of weaker than expected economic data which reminded investors that the US economy was not out of danger yet. Data showing a record trade deficit, unexpectedly high inflation and a weak labour market, pulled the dollar lower as markets refocused their attention on economic fundamentals.

The US government report said that January wholesale prices soared at the fastest pace in over a decade while the current account deficit sky rocketed to a record 44 billion in December 2002 versus estimates of a rise to 38 billion taking the annual figure to $ 435 billion. Wider deficits usually hurt the dollar since more cash is taken out of the US to pay for foreign goods while weak US financial markets remain unattractive to overseas capital.

An announcement by Germany's influential Ifo institute which stated that it was cutting its 2003 growth forecast from 1.1 percent to 0.9 percent was largely ignored by markets which took a turn at focusing on the dollar's problems. The week ended in much the same fashion it started as a rally in Wall Street shares fuelled demand for the US currency, helping it to rebound strongly from 3-week lows tested earlier.

A further set of economic data, which were largely in line with expectations, and an accidental explosion in a New York harbour earlier perceived to be a terror attack were sidelined as renewed investor appetite for dollars kept the greenback supported.

Next week, the release of German the Ifo business sentiment index and developments in the Iraqi situation will take centre stage as markets look for further clues on the direction of the European single currency.

Range for the week: $ 1.0550 - $1.0900.

Japanese Yen

The Japanese yen put up one of its strongest performances of the recent past, during the last week as seasonal demand from Japanese investors bringing their funds home kept the yen on a strong pedestal.

As markets remained embroiled between an impending war with Iraq and a stagnant global economy, the yen rallied as Japan prepared for its fiscal year-end on 31 March. Whilst Iraq remained to be a major headache, the yen provided an alternate investment for many speculators hungry for action in an otherwise lacklustre foreign exchange market.

Yen bulls were also encouraged by speculation that Japanese authorities may not be able to intervene heavily ahead of a meeting of G7 ministers and central bankers this weekend. However, comments by top financial diplomat Zembei Mizoguchi who stated that the yen's sudden jump had been too rapid were interpreted by markets as a warning that the Bank of Japan remained vigilant to excessive strengthening in the currency.

Mizoguchi's comments dampened speculation Japan quit its campaign to halt the yen's export crippling rise, which was sparked when finance minister Masajuro Shiokawa said that currency values would not be discussed at the G7 meeting. Prime Minister Koizumi added to the chorus saying that current yen strength was not good for the Japanese economy.

US figures showing an alarming jump in producer costs driven by a surge in energy prices and a record trade deficit accelerated the yen's gains as the currency climbed to a new 3-week high of 118.12 towards the end of the week. The dollar was saved from further embarrassment after a weekend surge on Wall Street made investors buy back their dollars, as markets started refocusing on economic fundamentals due to receding fears of an immediate attack on Iraq.

The release of Japan's industrial production and construction orders data for January will be the prime focus next week, but the yen is likely to receive support from continued repatriation flows.

Range for the week: 116.50 -120.00.

Sterling

Sterling perhaps suffered the worst week of the New Year as a surprise cut in British interest rates at the beginning of this month started taking its toll on the currency.

Analysts stated that everything from economic data to repeated scares of terror were weighing on the pound heavily as global anti war demonstrations escalated and boosted the greenback.
Sterling continued to under perform as markets persisted with their negative reaction to the UK's role in the Gulf as analysts said that the UK economy could slow down faster than its European counterparts.

As investors increasingly started focusing on Britain's economic outlook, sterling took a "Wild Wadi" ride down as it hit a fresh 3 ½ year low against the euro and a 7-week low against the greenback respectively.

Meanwhile, Britain's entry into the euro zone continued to percolate on the back burner with Prime Minister Blair dismissing speculation that he was poised to rule out a referendum on joining the single currency.

Blair's statement followed a Financial Times publication of a survey that showed Britain stood to lose substantial sums of investment if it delayed euro zone entry. News that Britain and the US were planning a fresh UN resolution for military action renewed pressure on the pound taking it down towards key chart level of 1.5800.

Data which showed a larger than expected fall of 1 pct in UK January retail sales proved to be the final nail in the coffin, as the pound dipped to its lowest level in nearly 4 years against the euro.

Sterling will face a firm test next week as the release of a second estimate of fourth quarter GDP and UK consumer confidence will be scrutinised closely by investors for further insight into the state of the British economy.

Range for the week: $ 1.5650 - $ 1.6000.