The ECB Has Room to Raise Interest Rates?! (page 1 of 2)

DailyFX Fundamentals 07-25-08

By Kathy Lien, Chief Strategist of DailyFX.com

Dollar rallies on strong data, but watch out for a big week

Stronger economic data has driven the US dollar higher against many of the major currencies.

New home sales, consumer confidence and durable goods were all better than the market expected, a sign that the mood of US consumers and businesses may be changing.

The number of new homes sold in the month of June was more than the market expected, but the big surprise was the 50,000 unit revision to the past three months of data and the reduction in inventory.

The numbers indicate that there is still decent activity in the housing market and even though house prices are down on an annualized basis, the median price of a home sold has increased from the prior month.

The final University of Michigan consumer confidence numbers also rebounded to a three month high after falling to a 28 year low in June while durable goods increased 0.8% compared to the market's -0.3% forecast.

Today's economic releases were almost too good to be true and for that reason, we are cautiously bullish.

With that said, it is quite impressive that the US dollar has shaken off risk aversion.

The divergence between the price action of the US dollar, the stock market, gold and oil prices indicate that risk aversion yesterday was limited despite the 280 point drop in the Dow.

If you recall, the dollar dropped only against the Japanese Yen, and rallied against all of the other G10 currencies.

Looking ahead, consumer confidence and house prices are due for release on Tuesday.

Given this week's upside surprises, both reports could be dollar bullish. However second quarter GDP, non-farm payrolls and manufacturing ISM which are due at the end of the week could turn things around for the dollar.

There have been no end to the layoff announcements and not only do we believe that non-farm payrolls will drop for the seventh straight month, but the job losses could be far worse than the market's -75k forecast.

The ECB has room to raise interest rates?!

The Euro strengthened against the US dollar but the rally has been marginal.

Unsurprisingly, inflation last month was hot with import prices rising 1.5% in Germany.

Despite the recent deterioration in Eurozone economic data, European Central Bank officials have been revving up their degree of hawkishness which leads many people to wonder whether the ECB is digging themselves into a hole.

ECB member Liebscher said this morning that the central bank has room to raise interest rates and that it is absolutely necessary to prevent any possibilities of so-called second-round effects.

Unlike the Federal Reserve who needs to worry about growth as much as inflation, targeting inflation is the ECB's primary focus.

In order to get their attention, we may need to start seeing negative quarterly GDP growth.

The central bank only worries about growth when it has fallen below potential.

Recent economic data clearly indicates that the region is slowing and if oil prices remain at $125 a barrel, the ECB's concerns about inflation will start to ease, allowing them to become more sensitive to growth.

In the week ahead, retail PMI and German unemployment are the big Eurozone releases.

We expect this data to continue to be Euro bearish.