US interest rates on the way up

Oil continued to rally as it sprinted past $ 57 a barrel forcing the OPEC to announce a hike in output; although it had little impact on cooling down prices.

The Federal Open Market Committee of the US Federal Reserve meets next week with wide expectations of a 25bps hike in US interest rates, whilst the accompanying statement is likely to draw significant attention for signs of a change in the Fed's approach.

Euro

The euro started the week on a strong pedestal, benefiting from news of a widened reading of the US trade deficit released at the end of the previous week.

As markets awaited the release of US Capital inflow data to gauge how well the United States had fared in attracting foreign capital, the dollar traded within ranges seen since the end of the previous week.

The euro suffered a minor setback in the run up to the data release, as market optimism first ran high and then subsided just before the data, only to return after the number came in at a staggering $ 91.3 Billion, against expectations of $ 60 billion.

The data helped alleviate fears of the United States being unable to attract foreign capital and pushed the euro towards the lower end of the $ 1.3300 - 1.3400 range.

However, the mid-week release of US 4Q '04 current account deficit data, which showed a record $ 187.9 Billion against an expected $ 181.6 Billion put the brakes on any fresh dollar gains, helping the euro climb above $ 1.3400.

The data showed that the current account deficit stood at 6.3 pct of GDP on an annualised basis, giving rise to questions of the country's ability to cope with the twin deficits - currently running at record levels.

Meanwhile, an announcement by the world's largest carmaker - General Motors, warning that it saw a threat to its profits in 2005, triggered a sell-off in US stocks taking the Down and Nasdaq down by over 1 pct, and piling more agony on the greenback.

Oil prices, which reached a record level above $ 57 a barrel, were also seen to be hurting the dollar's long-term prospects although reaction was muted. An announcement by OPEC of an increase in output failed to help, as market players dismissed the hike as "insufficient" to meet increasing global demand.

As the week drew to a close, focus shifted towards the upcoming meeting of the US Federal Open Market Committee meeting slated for next week, with expectations sky-high for a hike of 25bps in the Fed's overnight lending rate. The Fed funds rate currently stands at 2.5 pct, following six increases since June 2004.

The Fed's policy statement that follows will also be watched closely for a change in it's "measured' language, as a pick up in economic activity and inflation is likely to be addressed with aggression from the US policy makers.

In addition, the release of US PPI and CPI for February may also have an impact on currency markets as any signs of a pick up in inflation may be interpreted as dollar positive due to its impact on interest rates.

Range for this week: $1.3200-$1.3500

Yen

The yen commenced the week on a defensive note, after coming under pressure early on following the release of data showing a narrowing in the Japanese current account surplus by 28.2 pct in January from a year earlier.

An upward revision to the country's GDP for the last quarter of 2004, failed to help the currency as the pick up was largely attributed to a rise in inventories, signalling weaker demand.

The release of healthy US Capital Inflow data which helped the dollar regain its footing, hurt the yen further as it got shoved towards 105 yen per dollar, before finding support from exporter sales of dollars ahead of the Japanese fiscal year-end.

As the week progressed, the Japanese yen was restricted to the 104-105 range as higher oil prices were viewed as an obstacle towards future economic growth in Japan. A decision by the Bank of Japan to keep monetary policy unchanged also went unnoticed as the currency remained dependent on developments in the United States and energy prices for direction.

Whilst a record US current account gap briefly saw the yen testing 103.91 per dollar, weekend trading halted all its gains and pushed it back to 105 although repatriation flows kept a check on further yen losses.

The release of Japanese inflation data will be the highlight of next week, but the yen's fortunes are likely to lie with movements in the greenback and crude oil prices with support coming from repatriation related buying from investors and exporters.

Range for this week: Y102.50-Y105.50

Sterling

Sterling traded sideways during a week of fluctuating fortunes as uncertainty over the future of rate hikes in Britain and mixed economic data from across the Atlantic kept the currency within recent ranges.

With analysts increasing their bets on a rate hike in June, focus centred on the release of the UK budget, retail sales and jobs data for further clues on the direction of UK interest rates - now at 4.75 pct and amongst the highest of G7 nations.

The release of British jobs data, that showed a strong gain in wage growth, but a smaller than expected drop in unemployment had little impact, as the currency remained steady in the run up to the release of the UK budget.

Average British pay packets grew by 4.4 pct in the three months to January, higher than forecasts of 4.2pct growth, whilst the number of citizens claiming unemployment benefits dropped by 700, less than expectations of an estimated 5000.

Meanwhile, the release of the UK budget showing a Public Sector Net Borrowing of GBP 34.4 Billion was greeted with muted reaction, as the Pound rose against the dollar on the back of a record shortfall in the US current account.

The release of UK retail sales, which rose 0.2 pct as expected, was largely ignored as Sterling came under renewed pressure following a weekend revival in the US dollar. The release of the Bank of England's minutes of the last meeting will be the main focus of the coming week, as markets continue their hunt for further clues on the direction of British interest rates.

Range for this week: $1.9075-$1.9375