Euro drops against US dollar

Euro

Euro started the week on a watchful mood as market players were ready to dump euro against the dollar on expectations that a 50 basis point interest rate cut in US would help revive the world's biggest economy and the economic recovery in US would be faster than the euro zone.

A rate cut is seen as negative for the dollar in a market where higher yielding currencies perform the best but a recent rebound on Wall Street has shifted investor focus onto equities, which favour a growth boosting easing. Analysts said the Fed's rationale for its decision will be as important the actual move.

In Europe, European Central Bank council member Ernst Welteke discouraged talks of further euro zone rate cuts or intervention to curb the strong euro and the Bundesbank said in its monthly report Germany showed no signs of sliding into deflation at the moment.

He also said that the inflation in Europe would have to fall even further over the medium term before interest rates in euro zone could come down any further. Euro was also supported by a stronger than expected German Ifo business sentiment index, a second straight monthly rise to 88.8 in June from May's 87.6, beating the analysts' expectations.

As the countdown to the decision on US interest rates came closer the greenback was pinned to tight range as most market players were on tenterhooks awaiting the outcome on the Fed's meeting. It was considered a foregone conclusion that the Fed would cut rate as an "insurance" move to help re-ignite US economic growth.

While the financial market was on a wait and watch mode, US consumer confidence index for June came in at 83.5, beating expectations of a drop to 82.4. The consumer confidence data gave a mild boost to the greenback. However, US durable goods fell in May against expectations for an increase. The only bright spot of the US economy was the surge in new and existing home sales.

The Federal Reserve cut U.S. interest rates a quarter percentage point to 1958 lows and suggested it stood ready to take more action if the risk of falling prices worsened.

The central bank's rate-setting Federal Open Market Committee trimmed the bellwether federal funds rate for overnight loans between banks to 1 percent, the 13th rate reduction since early 2001 in a campaign aimed at nursing the economy through a recession and back to vigorous health.

All but one member of the committee voted for the cut with San Francisco Federal Reserve President Robert Parry pushing for a more aggressive half-point reduction. "Recent signs point to a firming in spending, markedly improved financial conditions and labour and product markets that are stabilising," the FOMC said in its post-meeting statement.

"The economy, nonetheless, has yet to exhibit sustainable growth. With inflationary expectations subdued, the committee judged that a slightly more expansive monetary policy would add further support for an economy which it expects to improve over time," it added.

Markets gyrated following the decision with blue-chip stocks falling and Treasury bonds turning lower but the dollar rising. Many in financial markets had been hoping for a larger reduction. As in its statement following its meeting on May 6, the Fed was sanguine about prospects for future growth even as it voiced concern about the risk of deflation or falling prices. "On balance, the committee believes that the latter concern is likely to predominate for the foreseeable future."

Recent data have shown the economy is still crawling back from a relatively mild recession in 2001, a sluggish pace that has pushed the unemployment rate to above 6 percent from under 4 percent late in 2000.

Gross domestic product has expanded at around a 2 percent annual rate, well under the 3-to-3.5 percent pace seen as the U.S. economy's long-term potential for growth. The single bright spot -- largely stemming from low interest rates -- has been housing. Other key sectors like manufacturing have been in the doldrums.

By the end of the week, greenback rallied higher helped by rising equity markets and expectations of stronger growth in the United States. Concern about job losses overshadowed relief about continuing low interest rates, the University of Michigan's well-regarded consumer confidence survey indicated.

More than 2 million US jobs have been lost in the past two years. While worries about the continuing paucity of work has been reflected in rising unemployment insurance payouts, although the growth in new claims seems to be slowing. Friday's University of Michigan figures showed confidence dipping in June, compared to the May figure.

But they were still better than many economists had feared. June's University of Michigan reading, as the survey is nicknamed, came in at 89.7, a fall from 92.1 the month before - but an improvement on the 87.5 economists had expected.

Elsewhere, euro zone current account data for April showed the region moved into mild deficit that month from a surplus in March and investment capital began to pour out of the region, although the average six monthly flows had been positive.

Range for the week: $1.1200 - $1.1700


Yen

Japanese yen traded in tight ranges for most of the week, as the market players were more interested in trading the higher yielding currencies. Fears of intervention underpinned the dollar round 117.50 yen.

But the yen's up trend has been limited as retail investors continued to flock to foreign bonds and investment trusts, especially in high-yielding currencies such as Australian, New Zealand and Canadian dollars.

Mid-week, yen started rising against the dollar due to demand from Japanese exporters trying to meet month-end obligations, until it suddenly reversed course.

Japanese monetary authorities have intervened in the market covertly to limit the yen's rise over the past few months in a bid to protect the competitiveness of the export reliant economy. By the end of the week, greenback had touched a high of 120.04 yen.

Range for the week: 116.00 - 121.00


Sterling

Sterling also started the week trading in tight ranges as the market was focused on the US interest rate decision.

As the week progressed sterling slipped against the dollar and euro after Bank of England Governor Sir Edward George said the pound's recent fall is helping to cushion Britain from the full impact of global economic weakness.

In a testimony to parliament's Treasury Select Committee, George added he did not see much chance of a big bounce in the exchange rate and the decline so far would raise the upside risks to inflation at the end of the BoE's two-year forecast horizon.

The British economy expanded at its weakest pace in 11 years in the first quarter as businesses and consumers retrenched in the run-up to the war in Iraq revised official data showed. The Office for National Statistics (ONS) said that GDP rose by only 0.1 percent in the first quarter, lower than the 0.2 percent previous estimate and average forecast by analysts.

The ONS said this was the weakest growth rate since the second quarter of 1992 when the British economy was struggling out of recession. On the year, GDP rose by 2.1 percent, down from the 2.2 percent estimate last month and the weakest rate in a year.

Markets mostly shrugged off the data as analysts reckoned that the Bank of England would be looking to more recent figures when it next meets to set interest rates. The BoE last cut borrowing costs in February to a 48-year low of 3.75 percent and many analysts expect it to cut again in the next few months if the economy keeps showing signs of weakness.

UK saw a current account surplus in the first quarter, Britain's first surplus since 1998. Data showed a first quarter current account surplus of 2.4 billion pounds versus a revised 1.8 billion-pound deficit in the forth quarter.

Range for the week: $1.6350 - 1.6850