Euro Breaks Higher as Market Shifts Focus to ECB (page 1 of 2)

DailyFX Fundamentals 06-25-08

By Kathy Lien, Chief Strategist of DailyFX.com

Is the Dollar rally over?

The Federal Reserve left interest rates unchanged at 2% and upgraded their degree of hawkishness but unfortunately for dollar bulls, the Fed was not hawkish enough (Detailed Take on the FOMC).

What currency traders came to realize was that even though the Fed could still raise interest rates in September, the ECB will beat them to them punch.

Federal Reserve members are in no rush to show their cards because time is on their side.

With two non-farm payrolls and multiple inflation reports before the next Fed meeting, the US central bank will get a much better sense of whether US consumers and businesses can handle a rate hike.

In the meantime the dollar may continue to let off some steam, particularly against the Euro.

Non-farm payrolls and the European Central Bank meeting are both scheduled for the same day next week, which could give us two reasons to sell the US dollar.

However any further weakness should just be a bump in the road for the US dollar because the ECB has already forewarned the markets that the July rate hike may be one-off.

Therefore the focus will shift back to the Federal Reserve, whose next move will be a rate hike. If inflation refuses to ease over the next few months, the Fed may be forced to tighten monetary policy more than once.

In that case, they could be perceived as more hawkish than the ECB, which would help the dollar recover. This is of course assumes that economic conditions do not get progressively worse over the next two months and inflation does not suddenly drop.

Durable goods orders and new home sales elicited nothing more than a yawn as both numbers came out very close to expectations.

The final figures for first quarter GDP, jobless claims and existing home sales are due for release tomorrow. All three pieces of data are expected to be dollar bullish with GDP predicted to be revised higher and existing home sales expected to rebound.

Euro breaks higher as market shifts focus to ECB

The currency pair that had the most significant reaction to the FOMC announcement was the EUR/USD. With the Fed meeting behind us, the ECB is the only central bank expected to make any changes in interest rates over the next two months.

ECB President Trichet said this morning that there is an acute risk of wage price spiral and reminded the market that they could raise interest rate 25bp at the next meeting.

The ECB's intentions should be quite clear and with a little more than one week to the ECB meeting, the market may continue to bid up Euros against US dollars simply because one central bank will be raising interest rates while another remains stationary.

This would widen the gap between Eurozone and US interest rates from 200 to 225bp in the Euro's favour.

In the meantime, good news is still being reported from the Eurozone. Industrial new orders jumped 2.5% in the month of April, well above the market's -0.5% forecast.

German import prices are due for release tomorrow and given the rise in oil prices last month, we expect import prices to continue to edge higher.

The ECB also has no problems with further Euro strength. According to ECB member Wellink, the equilibrium rate for the Euro is around 1.60. The central bank wants the Euro to rise because they know it will help to ease inflationary pressures.