Geopolitical tensions test the dollar

Euro

At the start of the week, the dollar was undermined against the euro on news that the head of Iraq's U.S.-appointed Governing Council was killed in a car bomb in Baghdad and after four small bombs exploded outside branches of HSBC Bank in Turkey, hours before British Prime Minister Tony Blair was due in the country.

Adding to dollar's weakness was also the U.S. Treasury report that said net capital inflows totalled $78.6 billion in March, down from February's revised $83.3 billion. The report painted a mixed picture for U.S. assets so far in 2004.

As the week advanced, the dollar trimmed its early losses as market participants returned to focus on the U.S. economic recovery and the belief that the U.S. could increase the interest rates sooner than later.

Minneapolis U.S. Federal Reserve President Gary Stern said financial markets were right to expect an interest rates hike before long. Philadelphia Fed Governor Anthony Santomero also gave mild support to the dollar, saying U.S. economic growth was sustainable and inflation would likely stay contained.

Meanwhile, Richmond Fed President Alfred Broaddus mentioned that an upswing in core inflation had grabbed the Fed's attention and the Fed is committed to keep a lid on inflation.

News that Alan Greenspan has accepted a White House nomination to serve another term as the Chairman of the Federal Reserve also gave the dollar mild support.

Moreover, the U.S. unit received further boost against the euro after the German ZEW gauge of economic optimism fell to 46.4 in May, the lowest since last July, from 49.7 in April.

Close to the weekend, remarks from Federal Reserve officials raised doubts over how quickly the U.S. central bank would hike interest rates. Fed Governor Ben Bernanke stated that inflation was stable and the bank should be able to push interest rates up at a gradual pace.

In addition, the greenback tumbled marginally on a fairly weak reading in the Philadelphia Federal Reserve Bank's gauge of mid-Atlantic regional manufacturing, which showed industry slowed to 23.8 in May from 32.5 in April, against forecast of 32.0.

Market will focus on the outcomes of both meeting of Group of Seven finance ministers in New York and an informal gathering of OPEC ministers in Amsterdam scheduled for the weekend. The effect of higher oil prices on the global economy is likely to be discussed in the meetings as oil prices hit record highs of over $40 per barrel.

On the economic front, next week, market will watch consumer confidence data and government report on durable goods orders in United States.

Range for the week: $1.1850 -$1.2050.

Japanese Yen

The yen firmed broadly on news that the Japanese economy grew faster than expected in the first three months of 2004. Japan's gross domestic product (GDP) rose by annualised 5.6 pct in January-March from the previous quarter, beating market expectations of 3.6 pct and outstripping U.S. growth of 4.2 pct in the same period.

The Nikkei stock average rose 4.4 pct within two trading sessions on the back of strong GDP numbers. In addition, a batch of Japanese economic data provided the yen fuel to move higher against the dollar.

Japan's current account surplus of 17.27 trillion yen ($150.7 billion) for fiscal year 2003/04 was the largest on record, while the domestic corporate goods price index was up 0.1 pct in April from the previous month.

Meanwhile, the Bank of Japan left monetary policy unchanged after a two-day policy meeting, which had muted reaction on the yen's trend.

Range for the week: 111.00 - 114.00

Sterling

Sterling was briefly hurt at the beginning of the week by British inflation data, which increased 1.2 pct year-on-year, compared with 1.1 pct in March.

As the week progressed, the pound erased its early losses and surged against the dollar and the euro after the Bank of England's minutes showed policy makers voted unanimously for a 25 basis point hike this month.

The BoE's Monetary Policy Committee member voted 9-0 to hike interest rates by a quarter point from its current interest rates of 4.25 pct. The minutes also reported that they discussed a 50 basis points rate hike.

The sterling's rally was further aided by robust mortgage lending data, which bolstered market expectations that British interest rates would rise significantly over the course of the year. British mortgage lending rose 6.4 billion pounds in April, its fastest pace since the British Bankers' Association records began in 1997.

Range for the week: $1.7650 - $1.7950