US dollar rides high on rate debate

All major currencies were forced to test multi-month lows as the dollar was caught in a transition mode largely due to growing expectations of higher US interest rates. Currency markets are likely to remain range bound in the week ahead as investors continue to look for clues on the possible timing of a rate hike in the United States.

Euro

The European single currency commenced the week on a negative tone after having been squashed by the previous week's impressive US jobs data, which reinforced market expectations of a US interest rate rise in the near future.

As investors remained on the look out for further clues on the timing of a possible policy move by the Fed, markets started focussing on key technical barriers, with a break of $ 1.1750 likely to open the way for further losses - possibly $ 1.1500. As the week progressed, the dollar remained well supported, but was unable to make much headway in the absence of any major economic data.

The release of much anticipated US trade data for March provided a jolt as the deficit ballooned to a record $ 45.96 Billion, mainly due to rising fuel prices. The data added a breath of confusion to the markets as investors pushed back expectations of rate hikes and questioned the country's sketchy economic record.

The euro, which recovered after having dipped to $ 1.1790, failed to take advantage as it only managed to reach $ 1.1900 levels, facing stiff resistance from traders booking profits on short-term positions. As markets geared up for the weekend flush of US data, the euro settled in to a comfort zone between $ 1.1800 and $ 1.1900 due to uncertainty surrounding the timing of the next rate hike in the World's largest economy.

Meanwhile in the United States, producer prices came in higher than expected showing a gain of 0.7 pct in April, but an unexpected rise in the weekly jobless claims data kept a check on the greenback's gains.

The weekend provided more insight into the US economy, with the release of US consumer prices, which rose a meagre 0.2 pct, against expectations of a 0.3 pct gain, whilst the topping on the cake came from the University of Michigan, which stated that it's preliminary reading of the consumer sentiment index for May remained unchanged at 94.2 - below market expectations of a rise to 96.5. US industrial production also gained in April, coming in at 0.8 pct, above expectations of 0.7 pct.

The data painted a mixed picture of the US economy and failed to give the dollar any direction. With the United States taking a break from the release of economic data, markets are likely to focus attention on the release of the German ZEW business survey and the ECB meeting for further clues into the state of the euro zone's economy, and the direction of Europe's single currency.

Range for the week: $1.1750 - $1.2050.

Japanese Yen

The Japanese yen experienced heavy volatility during the past week as swings in the Nikkei index and rising oil prices coupled with a broadly stronger dollar kept the currency under pressure.

The yen kicked off on a weak note as the dollar extended its gains of the previous week testing fresh 8-month highs following upbeat US employment data and hopes of an imminent rate hike in United States. A large sell-off in the Nikkei stock index also put pressure on the yen as the currency looked on track for a test of 115.00 yen to a dollar - last seen in September 2003.

Meanwhile, a surprise rebound in the Nikkei helped the yen recoup some of its losses, but the joy was short-lived as soaring oil prices raised concern amongst investors watching Japan's economic recovery.

With market attention increasingly focussed upon the recovery of the US economy and the timing of the next interest rate hike in the United States, the Japanese yen continued to remain under pressure as it was pushed above 114.00 to a dollar by investors betting on higher US rates.

The midweek release of a record US trade deficit failed to lift the yen as market players retained their appetite for dollars, largely due to expectations for higher rates in the near term. Japanese first quarter GDP and current account figures due to be released in the coming week will be focused upon closely, whilst foreign profit-taking in the Nikkei is likely to add further pressure on the Japanese currency.

Range for the week: 112.50 - 115.50

Sterling

The British Pound remained under pressure at the onset of the week largely due to broad-based dollar strength and relied on movements in euro/dollar for direction.

News of a surprising fall in UK manufacturing data for March, added further pressure on Sterling as it cast doubts on the future of British interest rates - widely expected to stand at 5.0 pct by the end of 2004.

The data knocked Sterling lower towards a five-month low of $ 1.7530, but the release of an upbeat inflation report by the Bank of England the following day aided the currency to climb higher and erase most of its losses.

The Bank of England stated that price growth in the United Kingdom would move above the official target of 2.0 pct, and warned that inflation would still be a little above target in two years even if British interest rates rose in line with market expectations.

The report reinforced previous expectations of higher interest rates and pushed the currency higher, whilst separate data showing Britain's trade gap remained steady in March had little impact on the currency's fortunes.

Sterling will face a stern test of character in the week ahead as the release of UK inflation and retail sales data is likely to have an impact on expectations of higher rates.

In addition, the release of minutes from the Bank of England's Monetary Policy Committee meeting, where interest rates were raised by 25 bps is also likely to grab attention as investors are likely to continue their attempts at reading the minds of policy makers.

Range for the week: $1.7500 - $1.7800.