Interest rates in the spotlight

Euro

The European single currency started the week on the back foot mainly due to its losses against the yen and sterling. Against the U.S. dollar it was holding around the $ 1.1500 levels and got a sigh of relief from positive data out of the euro zone.

Germany's influential ZEW index for investor expectations rose to a 16- month high. In September it jumped more than expected to 67.2, boosted by strong orders, a stock market rally and a weaker euro.

Another encouraging piece of data for the euro zone was German exports, which rose 5.6 percent year on year in September, and intervention by Japanese authorities against the dollar which saw the euro rise against the yen.

Nevertheless, euro's rise was modest mainly due to matching positive figures from the U.S. Separately, Germany's council of economic advisors issued a report predicting 2004 GDP growth at 1.4-1.7%, basing its forecast on the extent to which planned reforms and tax cuts pass through economy.

ECB Chief Economist Otmar Issing threw another optimistic note to Euro zone prospects saying that he grew more confident about regional growth than he did over the past 3 months. Issing also closed all hopes for any further ECB easing by saying that there was nothing more monetary policy can do.

Euro's rally gained speed, midway through the week, due to a number of factors including the lack of any U.S. data that left stocks lacklustre.

Growing trade tensions between the United States and its trading partners, a rising casualty toll in Iraq and sluggish equity markets were also catalysts that hurt dollar sentiment.

The European Union has threatened to start imposing sanctions on $2.2 billion of U.S. goods within a month if Washington does not scrap import duties. The prospect of global trade tensions comes after the World Trade Organization's highest court ruled that U.S. duties on steel imports violated global trade agreements.

The danger to the U.S. dollar would be less from EU sanctions but more from the threat that tensions could escalate. The end of the week saw the euro continue its rise against the dollar as mixed data out of U.S. clouded the outlook for economic recovery in the world's largest economy.

It all started with weak U.S. trade deficit data, which showed it had widened in September to $41.3 billion as the strengthening economy propelled imports from China and the rest of the world to record levels.

The trade shortfall was slightly higher than the consensus forecast of $40.5 billion. This put further stress on the need to attract U.S. investment to plug the gap and offset downward pressure on the dollar.

Also, first-time claims for U.S. unemployment benefits rose to 366,000 in the week ended Nov. 8 from a revised 353,000 the previous week. Markets were eyeing for a rise of 360,000.

Federal Reserve Chairman Alan Greenspan made no comment on interest rates in remarks to a conference in Washington. Whereas, European Central Bank chief economist Otmar Issing, who followed Greenspan, said he did not see deflation as a potential threat in the 12-nation euro zone economy.

The European single currency rose above the $1.1800 level against the dollar, on the very last working day of the week, due to lacklustre data out of the U.S. Data released showed a drop of 0.3 percent in October retail sales, close to economists' expectations of a 0.2 percent decline.

The producer price index overshot expectations, jumping 0.8 percent, compared with consensus forecasts for a 0.2 percent rise. The University of Michigan's November index of consumer sentiment rose to 93.5 from October's 89.6.

Furthermore in the euro zone, third-quarter gross domestic product data beat forecasts and showed the region grew at its fastest pace in a year at 0.4 percent on the quarter. Separately, data out of Italy showed it had swung back into growth in the third quarter at a stronger-than-expected pace of 0.5 percent. Germany and France also reported better-than-expected growth figures.

Range for the week: $1.1500 - $1.2000

Yen

The Japanese yen was slightly lower against the greenback, at the start of the week, due to falling Tokyo share prices, after a general election left Japanese Prime Minister Junichiro Koizumi in power with a reduced majority.

Tokyo stocks fell more than one percent, led by banking shares, after a dip in the number of LDP held seats in the general election clouded the outlook for reform.

The LDP lost the simple majority it had held on its own. It won only 237 seats against its previous 247. Japan's most senior financial diplomat, Zembei Mizoguchi, declined to comment on speculation thatn there could be a shift in the government's foreign exchange policy following the election.

The yen was also hurt by position adjustment after the dollar's fall last week despite strong U.S. data. Japan said at the beginning of the week it spent 7.5512 trillion yen ($69.09 billion) on intervention in July-September- a record high for a quarter- to stem the yen's rise.

All of the yen selling intervention was in the dollar/yen market, and said it spent 1.0667 trillion yen on September 30, when the ministry confirmed that it had sold yen for dollars in the foreign exchange market, acting through the New York Federal Reserve.

Although the smaller majority initially hurt Japanese stocks and the yen, the view that Koizumi weathered the election and consolidated his power in the divided LDP, helped push the Japanese currency higher, matching its three-year high of 107.85 yen against the dollar.

However, the Japanese currency fell sharply the following day as speculation grew that Japanese authorities had intervened in the market.

Ministry of Finance officials declined to comment on whether they had stepped in to stem the yen's rise. But market sources said that Japan had intervened in New York after the dollar retested three-year lows of around 107.85 yen, and again when the dollar was near 108.65 yen.

Japan's top financial diplomat, Zembei Mizoguchi, said he could not comment on whether Japan had in fact intervened, but said officials would not tolerate excessive currency moves. Furthermore, Japanese Finance Minister Sadakazu Tanigaki said the authorities would act against sudden movements.

The Japanese currency continued to rise against the dollar as Japanese shares rebounded from falls at the start of the week. Further helping the yen was fund repatriation by Japanese investors after euro denominated bond redemptions.

The yen briefly rose above the $ 108.00 level and close to three-year high after Japan's gross domestic product (GDP) in July-September came in better than expected. Japan's economy expanded by 0.6 percent in July-September from the previous quarter, double economists expectations in a Reuters poll, who had produced a median forecast of 0.3 percent.

However, the yen's rise was capped due to a fall in Japanese stock prices and wariness that the Japanese authorities may step in to stem any further rise in their currency.

Furthermore, Japan's top financial diplomat, Zembei Mizoguchi, said that the U.S. economy was still stronger than Japan's despite the latest GDP data and said authorities would be on alert for any overshooting in the currency market.

Range for the week: 106.00 - 111.00

Sterling

Sterling started the week stable against the U.S. dollar mainly due to few domestic factors available to affect the exchange rate.

However, midway through the week it fell across the board as news of an unexpected deterioration in Britain's trade position dampened sentiment ahead of the Bank of England's quarterly inflation report.

Data showed Britain's goods trade deficit with the rest of the world widened to 4.8 billion pounds in September, its worst reading since last November's all-time high of 5.1 billion pounds.

Nevertheless, the much awaited Bank of England's inflation report, which would be pivotal for sterling's near-term outlook, with traders eager to gauge how aggressively UK interest rates are likely to rise over the coming year, helped push sterling higher.

Backing up expectations of further hikes in the UK, the central bank raised its forecast for both economic and price growth forecasts in the inflation report.

The BoE said price growth would be above its 2.5 percent target in two years and warned that the longer house prices keep booming, the greater the risk of a crash. But it also said that the risks
to economic growth forecasts were on the downside.

Separately, October jobs data showed a strong state of the UK labour market. However, sterling was hurt by sentiment that more rate hikes would not take place till next near. Talks that a new rate hike may come later than markets are now pricing in, increased after a warning from BoE chief Mervyn King on the risks to debt-laden UK consumers from higher interest rates.

Nevertheless, sterling jumped to a 1-1/2 week high of $1.6888, at the end of the week mainly due to weak U.S. data.

Range for the week: $1.6650 - 1.7150