Currency markets shift focus away from war

War will drop from the markets' agenda next week, leaving the traditional preoccupations of corporate results, manufacturing, inflation and economic sentiment data to take centre stage.

Next week financial markets will concentrate on U.S. Consumer Price Index, which tracks retail - level inflation, plus housing starts, business inventories, industrial production and weekly jobless claims.

Over the next two weeks investors would tune in to what companies say about the quarter that just ended as well as watch their forecast for the second quarter. In Europe, Germany's ZEW survey will catch most attention while French and euro zone industrial data will also be watched.

Euro

The European single unit commenced the week on a weak tone on news that U.S. forces had made advances in the difficult and complicated job of invading the city of five million people and that the regime of Iraqi President Saddam Hussein was nearing an end.

The market thought a quick end to the fighting would benefit the dollar, as apart from the cost of war to the U.S. economy, anxiety about it has been seen holding back spending by consumers and companies. The dollar rose as high as 1.0559 against the euro after further positive news that U.S. forces had captured two of Saddam Hussein's palace complexes in Baghdad and British forces were walking unopposed into the centre of Basra, Iraq's second largest city.

Later in the week euro managed to regain its losses climbing marginally above $1.0800 level as expectations of quick end to the war were undermined by worries that the American economic outlook may not be that promising even after the war is over. Rapid U.S. progress in the war, once seen as synonymous with a quick recovery in the U.S. economy appeared to be losing the leverage to lift the dollar and shares.

Market focus shifted towards the weak underlying fundamentals of the U.S. economy as investors looked past a war in Iraq and found little to cheer. Looking ahead to the potential problems down the road, such as how much it will cost to rebuild Iraq gave an underlying bearish tone to the dollar. In addition data released on Tuesday showed that U.S. consumer confidence in early April had recovered but retail spending remained depressed.

Political difficulties over reconstruction of post - war Iraq also made investors cautious. U.S. President George W. Bush and British Prime Minister Tony Blair continued talks on the post-conflict future of Iraq at their summit in Northern Ireland. Both leaders endorsed a 'vital role' for the United Nations in Iraq, however President Bush mentioned only humanitarian work.

Midweek, the International Monetary Fund, warned that the global economy remained at risk. The IMF said that strong productivity, very low interest rates and the possibility of new U.S. tax cuts should enable U.S. gross domestic product to expand by 2.2 percent in 2003 and 3.6 percent in 2004. However, the institute noted that while the Fed's current policy was appropriate for now, further easing could be necessary.

The euro's rise was capped after U.S. television network Fox reported that marines might have found weapons-grade plutonium in an underground facility outside Baghdad. The news gave a lift to the dollar on views it could provide evidence for the U.S. contention that Iraq has weapons of mass destruction. Better than expected trade deficit figures provided additional support for the dollar.

The government reported that the U.S. Trade deficit narrowed to $40.3 billion in February versus forecasts of a widening to $41.12 billion. On the job front, initial jobless claims fell to a seasonally adjusted 405,000, under the 428,000 forecasted by economists. Jobs are essential for the economic growth because employment fuels consumer spending, which accounts for two-thirds of gross domestic product.

Further aid to the dollar came after U.S. Treasury Secretary John Snow reaffirmed his backing for a strong dollar policy. Meanwhile, the IMF report commented that the European Central Bank should consider additional rate cuts and adopt an inflation target of 2.5 percent, higher than current limit of 2 percent. Furthermore Eurozone growth projections were revised down to 1.1 percent in 2003 and 2.3 percent in 2004.

On the last trading day a round of strong economic data cheered the dollar and pushed it to high of 1.0692 versus the euro. Producer Price Index rose 1.5 percent in March versus a 1.0- percent increase in February. The core rate rose 0.7 percent when it was expected to remain unchanged. The University of Michigan reported an improvement in consumer confidence.

The index rose to 83.2 from 77.6 in March, yet failed to reach the most optimistic projections of a rise to 88. Commerce Department reported that U.S. retail sales rose 2.1 percent in March, more than 0.6 percent rise economists had expected and the biggest increase since October 2001. However, the dollar was not able to hold on to its gains as market had expected an even bigger increase.

In addition pullback in stocks pushed the currency lower. For the week, the Dow fell 0.89 percent, Nasdaq slipped 1.78 percent and the S&P 500 lost 1.2 percent. Market paid little attention to Group of seven finance ministers meeting in Washington, which is expected to focus on reconstruction of Iraq and unlikely to give more than a cursory nod to currencies.

Range for the week: $1.0500 - $1.1000

Yen

Japanese yen started the week on a soft note due to rapid progress made by U.S. and British troops in Iraq.

The dollar rose as high as 120.85 yen, however, heavy sell orders by Japanese exporters and profit taking on dollar - long positions halted the greenback's gains. The yen received mild support after Bank of Japan's Policy Board Meeting ended on Tuesday without any change to its monetary policy.

Under heavy political pressure to lift the economy out of the doldrums, the BoJ said it would consider expanding its operations to include buying asset-backed commercial paper (ABCP) directly from smaller firms. Japanese Finance Minister Masajuro Shiokawa said on Tuesday that he welcomed moves by the Bank of Japan to consider diversifying the way it provides liquidity to the financial system.

The yen came under renewed pressure after Bank of Japan in its monthly economic report said that Japanese economy remained flat, with the outlook increasingly uncertain as a result of geopolitical risks.

Meanwhile, the International Monetary Fund downwardly revised growth forecasts for Japan in the aftermath of the war, lowering it to 0.8% from its previous forecast of 1.1%. Japan's top financial diplomat, Zembei Mizoguchi, said that Japanese authorities remained alert against sudden volatility in the foreign exchange market.

Moreover, Nikkei average fell two percent to a 20-year low, with Japanese exporters like Toyota Motor Corp hard hit by pension fund selling and concerns about sluggish demand in the global economy. Fall in stocks would keep alive expectations of Japanese authorities intervening to stem any signs of export-damaging strength in the yen.

Range for the week: 117.50 - 122.50

Sterling

Sterling started the week under pressure due to dollar supportive news. Better than expected U.K manufacturing data was not enough to change the market's sentiment about the economy.

Data showed manufacturing output in Britain staged another surprise rise in February, beating analyst expectations of a small decline from the previous month. Manufacturing output, which accounts for a fifth of the economy, rose 0.3 percent in February from January. Financial markets were little affected following the U.K. budget announcement for the year 2003 / 2004.

British Chancellor of the Exchequer Gordon Brown downgraded his forecast for U.K. growth in 2003 to 2.0 - 2.5% from the previous estimate of 2.5 - 3.0%. Brown raised projections for government spending to 27 billion pounds from 24 billion, raising concerns that the government could see deterioration in its fiscal discipline.

Later in the week Sterling climbed higher versus the dollar due to worries that the U.S. economic outlook may not be that promising. Additionally, Sterling found support from waning prospects of early British entry to Europe's monetary union. It looks increasingly unlikely that Blair will hold a referendum during his current term in office on merging Sterling with the euro.

Bank of England decision to keep the interest rates unchanged at 3.75 percent provided extra support for Sterling, allowing it to maintain the yield advantage over the dollar. U.K. data due for next week include U.K March PPI on Monday, U.K March RPIX on Tuesday and U.K March employment due on Wednesday. RPIX, which excludes volatile home loan payments, rose by 3.0 percent year-on-year in February, up from 2.7 percent in January. The Bank of England targets PRIX inflation at 2.5 percent.

Range for the week: $1.5500 - $1.6000