Markets back on a war footing

Euro

The week began with market players looking ahead to a weighty batch of economic data and bracing themselves for crucial developments on geo-political front. The first in line of major data releases came about in the form of weaker-than-expected U.S. manufacturing figures from the Institute for Supply Management (ISM).

The data laid the foundation for a negative dollar bias as it showed the index slipped to 50.5 in February, from 53.9 a month earlier. Concerns about a possible war with Iraq being a "major deterrent" for many industries was cited as the main reason for the dip. In contrast, the Reuters Eurozone Purchasing Managers' index released earlier on the same day beat consensus forecasts and rose to 50.1 in February from 49.3 in January.

The dollar's sell-off was given an extra impetus following the Turkish parliament's decision last weekend to block U.S. forces from using its military bases. Additionally, Iraq willingness to begin destroying its missiles also inspired dollar selling, as together the two developments led to speculation that a war could at least be delayed if not avoided and raise the costs an already shaky U.S. economy is likely to bear. Euro/dollar rose to a high to 1.0899 on these concerns.

Midweek, the greenback extended its losses across the board, after being dealt a severe blow by comments from US Treasury Secretary John Snow who stated he was not concerned by the dollar's recent decline. The comments triggered a full cent rally in euro/dollar, propelling the pair to fresh four-year highs above $1.10. The 'Snowstorm on the dollar' allowed the single currency to break away from its all-too-familiar recent trading ranges as it briefly diverted market attention from all the war rhetoric.

Treasury spokesman Tony Fratto later put a temporary brake on the euro's climb by saying Snow still favoured a strong dollar and that "the secretary's position has not changed". German Economic Minister Wolfgang Clement also helped put a halt on dollar losses as he stated that a euro above $1.10 could hurt Germany's export industry.

However, the damage had already been done and market attention again moved to geo-political issues with the White House saying it would persist with a U.N. resolution paving the way for war on Iraq even as France, Germany and Russia teamed up to block the move.

On the following day, the European Central Bank (ECB) cut its key interest rate by a modest quarter percent to stand at 2.5. The euro initially edged lower, but soon bounced back as the market assessed that the 25-basis point cut could be positive for the eurozone economy and thus for the euro. Investors betting on a more aggressive half point reduction were forced to buy back euros.

Warning signals on the health of the European economies had mushroomed prior to the ECB announcement, with the Paris-based Organisation for Economic Co-operation and Development (OECD) saying its 2003 forecast for euro zone growth, currently at 1.8 percent, would likely be cut, while German data showed unemployment at five-year highs.

The dollar fell through a series of four-year lows against the euro on the last trading day as market conviction mounted that war in Iraq was imminent. The fears grew after U.S. President George Bush vowed to force a vote within days on a resolution authorising war, regardless of whether he could count on its passage.

Markets ignored a later report on Iraqi compliance with U.N. disarmament resolutions by chief U.N. arms inspector Hans Blix. A gloomy February U.S. payrolls report heaped additional pressure on to an already weak dollar, pushing euro/dollar to 1.1067 level, its highest since March 1999. The U.S. Labor department reported an unexpectedly large drop of 308,000 in the number of Americans employed last month, while the jobless rate edged up to 5.8 pct from 5.7 pct.

In late New York trading, the greenback recovered some of its losses on unconfirmed news reports that U.S. and Pakistani authorities might be closing in on Al Qaeda leader Osama bin Laden. The reports gave a strong boost to U.S. stocks and the dollar, which retreated back to 1.1007 level against the euro at close of the trading session.

Range for the week: $1.0750 - $1.1250

Japanese Yen

The yen started the week undermined against the dollar following confirmation late last week from Japan's Ministry of Finance (MoF) that it had covertly intervened in the forex market for the second consecutive month in February.

Traders were prompted to sell the Japanese currency after BoJ data revealed that it had spent approximately 500 billion-yen in February to curb excessive yen strength. USD/JPY hovered around the 118.20 level.

The greenback drifted lower against the yen in the course of the week amid broad-based dollar weakness. However intervention fears prevented dollar/yen from breaking below the key 117.00 level. Market talk remained rife that the Bank of Japan would be bidding for dollars in the 117.10-20 yen range.

On the last trading day, reports that the Bank of Japan had intervened to prop the dollar after the Japanese session close were never substantiated. But whatever action could have taken place proved futile as the dollar began tumbling ahead of the release of the US employment report, and later extended its fall to a 6-month low of 116.38.

The currency pair lost a full yen at the release of the US data and growing market conviction that war in Iraq was imminent, but later pared most of those losses to regain the 117 level. Meanwhile the Nikkei- 225 index fell 2.7% to end at 8,144, its lowest close in 20 years.

The yen may be subject to more gains as repatriation looms ahead of the current fiscal year end on March 31.

Range for the week: 115.50- 118.50

Sterling

Sterling also gained ground against the dollar despite the release of gloomy UK economic data. The Nationwide building society said house prices rose only 0.4 percent in February, the slowest pace since October 2001, suggesting that the heady price rises that have helped fuel a spending boom and insulate the economy from the worst of the global slowdown may finally be coming to an end.

Additionally, the Confederation of British Industry (CBI) reported lacklustre retail sales growth for the third consecutive month as the threat of a war and a slowdown in the housing market hit confidence. The market also got a reminder of the UK's exposure to Iraq risks as Britain's Chancellor of the Exchequer Gordon Brown pledged the government would find all the necessary money to fund a possible war with Iraq and the battle against international terrorism.

Most of the sterling's gains came about after U.S. Treasury Secretary Snow's comments raised fresh doubts over Washington's commitment to a strong dollar policy, and sent the greenback reeling across the board. Sterling rose to a two-week high at $1.5999 following Snow's comments. Meanwhile, the Bank of England's decision to keep interest rates unchanged at 3.75 percent was widely expected and had little impact on sterling.

Sterling tested levels of $1.6092 on the last trading day as mounting fears of an imminent U.S. led war against Iraq and poor U.S. employment data prompted flows out of the greenback.

Range for the week: $1.5800 - $1.6300