A roller-coaster ride for currencies

The European Central Bank delivered it's most aggressive rate cut in history by lowering rates to a record low of 2.0 pct, whilst the Bank of England decided to wait and left rates steady at 3.75 pct.

Both decisions triggered rallies in the respective currencies, but an encouraging reading on US non-farm payrolls helped the dollar regain some respectability at the end of the week; although many analysts believe that the greenback is likely to retain it's weakness for a prolonged period of time.

Euro

The euro kicked off on a defensive mode as a meeting of the world's most influential leaders commenced in Evian, France with markets speculating on a joint call for strengthening of the US dollar.

Comments by world leaders who called for a return of the dollar's strength seemed to be keeping a check on the buoyant euro as it was stuck in a range between $ 1.1650 - $ 1.1700. As the G8 summit drew to an end, the dollar started yet another slide as the failure by the G8 to make a joint communiqué on currencies prompted market players to commence selling the US unit.

The dollar's bullish sentiment was further dampened by the release of disappointing US manufacturing and construction data, which cast yet another shadow on the economic prospects of the United States. The Institute for Supply Management reported that its May manufacturing index rebounded to 49.4 from 45.4 in April, although still below the critical 50 level that separates growth from contraction.

The data failed to help the dollar as markets started focussing their attention on the upcoming ECB interest rate decision, with many analysts betting on a cut of 50 basis points. Federal Reserve chairman, Alan Greenspan, added some solace to the dollar's woes, after he said that the pace of growth in the US economy would quicken, but warned that it would be slower than some forecasts had implied.

He further stated that the risk of deflation was remote, and said that the cost of insuring against it was very low, leading the market to conclude that there was a greater chance of a rate cut at the next Fed meeting scheduled for the end of June.

Mid-week, as expectations of a yield-reducing interest rate cut by the European Central Bank gained momentum, the once high-flying euro came under pressure as dealers adjusted their positions by dumping the single currency against major currencies.

The dollar regained some lost ground after the US Institute of Supply Management said that it's May non-manufacturing index on the services sector rose to 54.5 from 50.7 in April, against forecasts of a reading of 52.0.

The European Central Bank, which met on Thursday, sprang no surprises and announced that it was trimming interest rates by 50 basis points, bringing the bench mark euro zone interest rate to it lowest level ever at 2.0 pct.

This rate cut proved to be a blessing in disguise as markets focussed on the long-term benefits of the rate cut to the European economy, rather than the narrowing of the interest rate differential between the two continents.

The euro rallied almost 2 pct in the aftermath of the ECB decision, whilst the release of US data indicating the largest drop in US factory orders for 17 months also aided the dollar's downfall. Analysts said that increased demand for the single currency from Arab and Middle Eastern investors, reluctant to invest in US treasuries was also seen as a factor supporting the single currency.

As the week drew to a close, the greenback staged a rally of its own after May US jobs data were considered not as bad as expected allowing the dollar to recover some lost ground.

May's unemployment rate rose to 6.1 pct as forecasted, but the number of jobs lost was only 17,000 and was better than the forecast of 39,000. Market attention next week will focus primarily on the release of US retail sales data for May, for further clues on the direction of the US economy, the dollar and interest rates.

Range for the week: $ 1.1600 - $ 1.2100.

Japanese Yen

The Japanese yen commenced the week on a mixed note as it came under pressure due to dollar-friendly comments by G8 leaders and dollar selling by Japanese exporters.

The dollar was also supported by wariness over possible intervention by the Bank of Japan after it conducted the largest ever yen-selling intervention in May, totalling four-trillion yen ($ 33.6 Billion), to stem the currency's rise.

The yen came under further pressure after Japanese Prime Minister Junihiro Koizumi told the G8 that he did not understand why the value of the yen was continuing to rise at a time when the Japanese economy is said to be in such bad shape. The dollar continued to firm against the yen helped by further comments from Japanese officials.

Haruhiko Kuroda, former vice finance minister for international affairs and now an advisor to Prime Minister Junihiro Koizumi, said in an interview that a dollar/yen exchange rate of 140 yen would be appropriate from a standpoint of purchasing power parity.

As the week progressed, market attention focussed on the European Central Bank's policy setting meeting, whilst the yen remained under pressure as the flow of comments from Japanese officials continued unabated.

Hiroshi Watanabe, head of the Finance Ministry's international bureau, said on Wednesday that his ministry would stay vigilant against speculative currency moves that pushed the yen higher.

Meanwhile, a rally by the European single currency, following a much awaited growth-boosting monetary easing, pushed the yen higher close to 117 yen per dollar, but caution over possible intervention kept a check on further gains.

Finance Minister Masajuro Shiokawa reiterated that Japan would take action in the foreign exchange market if found necessary, but added that the Government did not intent to manipulate currency rates.

Prime Minister Koizumi also joined the choir, saying that he wants to see a stable exchange rate. The yen ended the week with it's bearish tone intact as the dollar rallied aided by better than expected US non-farm payrolls data and rumours that the Bank of Japan had already intervened around 117.30 levels.

Range for the week: 116.00 -121.00.

Sterling

Sterling began the week on a calm note against the dollar and the euro and was unruffled by the release of the May factory survey conducted by the Chartered Institute of Purchasing and Supply Managers and Reuters showed the sector shrank more than expected in May.

With the Bank of England Monetary Policy Committee meeting scheduled for later in the week, sterling kept in step with euro/dollar rates, coming off recent four-month highs against the rebounding dollar but gaining against the retreating euro.

Data released by the Confederation of British Industry showed that Britain's services sector has stayed weak since the end of the Iraq war, with consumer service firms still affected by tepid demand.

Mid-week, the British pound retreated against the recovering dollar as markets showed little reaction to comments by Bank of England Governor Sir Edward George, who stated that there are potential benefits to euro entry but the one-size fits all interest rate would be a potential downside.

However, sterling received support by the CPI/Reuters services' sector survey index, which rose to 51.9 in May from 50.7 in April to record the highest reading since January. As the week came to a close the British Pound drew enormous support from the Bank of England's decision to leave interest rates steady as it confirmed Britain's status as a high-yielding destination for investors' funds.

Sterling was also aided by a broad pullback in the dollar, which was triggered by the ECB's decision to cut interest rates by half a percentage point, widely seen as a boost to economic growth in the euro zone. The move helped the pound to leap higher to a fresh 3-½ year high around $ 1.6700 levels as the currency increased its credence as a high-yielder.

Markets next week will focus attention on Chancellor of the Exchequer Gordon Brown, as he announces the results of the five economic tests carried out on euro entry to the British Parliament on Monday. Analysts said that the impact would be relatively minimal since Brown is likely to reject euro entry in the short-term.

Range for the week: $ 1.6350 - $ 1.6850.