Disappointing trend in the path towards an economic recovery

Euro
The greenback started the week, extending its heavy losses made against the euro after a previous week's far-weaker-than-expected U.S employment report cast doubt over the health of the economy and the pace at which the Federal Reserve would raise interest rates.

Federal Reserve Chairman Alan Greenspan said last month that weakness seen in June was likely to be a passing phenomenon, but the sell-off in equities and the dollar showed investors had become less convinced of this view.

The dollar rallied against the euro after the U.S Federal Reserve raised target-borrowing costs by 0.25 percent and reaffirmed its bullish view of the U.S. economy. The Fed's upbeat view on the economy came in the face of soaring oil prices and a recent batch of weaker than expected U.S. economic data. The Fed said that recent softness in U.S. output and employment data was likely due to a rise in energy prices, but added that the economy "nevertheless appears poised to resume a stronger pace of expansion going forward".

The dollar continued its gains after the number of Americans filing first claims for jobless pay dropped by 4,000 last week, a second straight weekly decline that appeared to reflect improving job prospects. The Labour Department reported that initial jobless claims dipped to 333,000 from 337,000 in the previous week, contrary to Wall Street economists' expectations that they would rise to 338,000.

The four-week moving average of claims also fell to 339,250 from 343,500 in the July 31 week. Furthermore, government report showed that U.S. shoppers returned to stores in July, however, the retail sales for the month posted a smaller than-expected- gain as consumers coped with the recent rises in energy prices.

The Commerce Department said retail sales rose 0.7 percent in July to a seasonally adjusted $336.50 billion, less than economists predicted but a rebound from the revised 0.5 decline in sales in June. The figures reflected a mixed picture of consumer spending, which accounts for about two-thirds of overall U.S. economic activity. With June sales revised up from the previously reported 1.1 percent decline, the "soft patch" in spending noted by Federal Reserve Chairman and others was not as deep as believed.

At the end of the week dollar was forced to give up its gains against the euro after data showed a record U.S. trade deficit in June cast fresh doubts on the economic recovery in the U.S. and its ability to draw foreign capital to fund the growing gap. Commerce department data showed that the deficit widened to a record $55.8 billion in June, defying expectations for a slight widening to $47.0 billion, as exports dropped and imports rose.

Furthermore, foreign investors sharply slowed the pace of their investment in the United States in May. Net capital inflows were $56.4 billion, down from $76.0 billion in April. Dollar also slipped in the wake of a report from the University of Michigan showing a decline in U.S. consumer sentiment. The preliminary reading of its August sentiment index was 94.0, compared with July's reading of 96.7. Forecasts had called for the August reading to reach 97.5. Other U.S. data showed U.S. producer prices rose less than expected in July.

The producer price index was up 0.1 percent, compared with a 0.3 percent decline in June. Excluding food and energy prices, the PPI rose 0.1 percent. The index had been expected to rise 0.2 percent with the core PPI forecast to be up 0.1 percent. Next week, financial markets would focus on U.S capital flow data for June due on Monday, in addition to U.S. CPI data that is due on Tuesday. In Europe, Germany's August ZEW report is predicted to fall from 48.4 to 48.0.

Range for the week: $1.2200 - $1.2500.


Japanese Yen
Japanese yen kicked off the week on a strong footing against the dollar. However, its gains were capped due to recent surge in oil prices to record highs, which is expected to hurt Japanese shares and put a brake on Japan's economic recovery. Japan's per-capita consumption of oil is only half that of the United States, but it is more dependent on imported oil. Meanwhile, the yen hardly reacted to the Bank of Japan's decision to keep its monetary easing policy intact at the end of its two-day meeting.

As the week progressed the yen crept higher, prodded by an upgrade in the IMF's economic outlook for Japan and ahead of an expected inflow of yen as Japanese investors repatriate coupon payments on U.S. Treasuries. In its annual review of the Japanese economy, the International Monetary Fund said, it expected real gross domestic product to rise 4.5 percent in 2004, revising its previous forecast of 3.4 percent growth. Furthermore, yen was supported by Saudi Arabia's confirmation that it had raised oil output sharply over the past three months and that it could meet extra demand.

The yen failed to take advantage of sluggish U.S economic data at the end of the week as surprisingly weak Japanese growth data cast doubt about the health of the world's second-largest economy. Japan, whose previous-quarter growth outpaced that of the United States and eurozone, saw its economy growing just 0.4 percent in the second quarter, less than half what the market had expected.

Range for the week: 109.00 - 112.00


Sterling
Sterling held firm against the dollar after data showed core output prices rose at their fastest pace in nearly nine years in July and house price inflation also increased in June. The office of the Deputy Prime Minister said the annual rate of house price inflation rose to 13.9 percent in June from 12.2 percent in May, suggesting interest rate rises had not cooled the red hot property market as policymakers had hoped.

As the week continued sterling failed to hold to its gains as weak British inflation data encouraged investors to scale back bets on future British interest rate rises. Consumer prices fell 0.3 percent in the month of July, more than analysts had forecast.

This brought the annual rate down to 1.4 percent, well below the Bank of England's 2.0 percent target. Furthermore, sterling came under additional pressure after Britain's trade gap with the rest of the world widened unexpectedly in June. The deterioration brought the quarterly good and services gap to a record 10.8 billion pounds from 9.2 billion pounds in the previous quarter.

In its much-awaited quarterly Inflation Report, the Bank of England said that its forecasts for both GDP growth and inflation were similar to those it made in May. BoE said inflation would hit its two- percent target in two years as long as interest rates rise in lien with the path currently implied by the market. The BoE also added that GDP growth is expected to remain above trend in the near-term before dipping below that level in the second year of that projection as domestic demand moderates.

Moreover, robust U.K. labour data failed to support the pound as investors focused on the inflation report. The U.K jobless claimant count fell 13,700 in July compared with a consensus for an 8,000 decline and June's 11,600, revised from a preliminary 9,600. On the last trading day sterling managed to regain its losses against the dollar on news that the U.S. trade deficit widened by a record gap than expected in June.

In the coming week financial markets attention would be focused on the U.K retail sales data and the minutes of the Bank of England's August meeting for more clues on the pace of future U.K rate rises.

Range for the week: $1.8300 - 1.8600