Inflation fears rattle currencies

Euro

Disappointing German business confidence survey and persistent worries over the implication of a "no" vote in France's referendum on the EU constitution next month kept the euro under pressure.

The Ifo institute's gauge of German business confidence fell for the third consecutive month in April, dropping to its lowest level in more than 18 months in a sign of continued weak economic growth. The headline index slipped 93.3 in April from 94.0 in March.

The dollar however scored broad gains the following day, helped by reports that showed U.S. new home sales surged to a record pace, pacifying some concerns about a slowdown in the U.S. economic recovery that had pressured the currency against the euro and the yen.

The much awaited U.S. consumer confidence measure came in lower at 97.7 against forecasts of 98.0, but received no major reaction as market players had already discounted a weaker reading, given the high energy prices and falling stock markets.

The dollar continued to hold on to its gains as traders grappled with data showing slower-than-expected U.S. growth in the first quarter and at the same time signs of rising inflation. A surge in inflation fuelled expectations that the Federal Reserve might quicken the pace of U.S. interest rate rises, enhancing the allure of dollar-denominated assets.

This helped offset the market's disappointment over 3.1 percent annualised economic growth in the first quarter, below forecasts of 3.6 percent and the slowest rate of growth in any given quarter for the past two years.

The overall implicit GDP price index came in higher than expected at 3.2 percent, although the year-on-year growth in core personal consumption expenditures (PCE) was a still subdued 1.6 percent.

The greenback dipped on the last trading day after the University of Michigan's April consumer sentiment reading came in at 87.7, undershooting economists' consensus forecast for a reading of 89.0. But the Chicago Purchasing Management April index supported the dollar at 65.6 above forecasts of 63.9.

In the coming week, all eyes will focus on the U.S. Federal Reserve Committee meeting scheduled for Tuesday, where members are widely expected to agree on a further interest rate rise. Investors will also scrutinise U.S. jobs and manufacturing data next week for clues on the pace of further U.S. interest rate hikes.

The Fed's willingness to raise rates, currently at 2.75 percent after seven rises, could be tempered by a recent patch of soft consumer data and corporate results, which also weighed on the dollar this week.

In the eurozone, markets will focus on April's Manufacturing PMI on Monday and the service sector PMI on Wednesday for broads signs concerning the region's economic health.

Range for this week: $1.2750-$1.3050

Yen

The Japanese yen leapt to a two-month high against the euro and one-month high versus the dollar as speculation intensified that China might soon revalue its currency.

Any revaluation of the Chinese yuan, which has been pegged near 8.28 to the dollar for the last decade, is expected to spark a broad rally in Asian currencies. In a flurry of comments, Chinese officials said the country was better prepared to loosen its currency peg although they did not give a time frame to do so.

Speaking at the start of the week, the deputy chief of China's foreign exchange regulator Wei Benhua said the country would "positively but prudently" speed up the reform of its currency peg.

Mid week, the yen eased marginally after disappointing Japanese data suggested the country needed more time to get its economic recovery back on track, though the currency soon recovered its losses on buying ahead of a market holiday.

Japanese industrial output fell 0.3 percent in March compared to the previous month, weakening the yen against the dollar and the euro.

The yen vaulted against the dollar and the euro on the last trading session as speculation intensified that China might move soon to allow its currency to trade more flexibly.

The state-run China Securities Journal fanned talk of an imminent revaluation by saying deepening reforms of commercial banks and the foreign exchange market have created conditions for China to adjust the yuan's trading band.

The yuan, which has traded in a band of 8.2760 to 8.2800 to the dollar since the 1997-98 Asian financial crisis, spiked briefly to a high of 8.27, before settling back. However, the Chinese central bank reiterated that there was no change in currency policy ahead of next week's Labor Day holiday in China and Golden Week holidays in Japan.

In the coming week, Chinese finance chief Jin Renqing will meet counterparts from Europe and Asia, including Japan Finance Minister Sadakazu Tanigaki, at the annual meeting of the Asian Development Bank next week.

Range for this week: Y104.00-Y107.00

Sterling

Sterling maintained a strong foothold against the dollar and the euro as a broad-based slide in Europe's single currency overshadowed soft data on the UK housing market.

The British Banker's Association said 65,635 loans had been approved in March 2005 compared to 47,365 a month ago and 97,852 in the same month a year earlier. The association said despite the March recovery it was too soon to say whether the housing market, which has slowed over the last six months was picking up.

Meanwhile markets shrugged off a survey showing UK consumer confidence worsened in April. The data comes less than a week before an election when the ruling Labour party vies for a third successive term on the back of its economic record.

The Bank of England's Monetary Policy Committee meets on May 6 and May 9 to discuss interest rates. However, it is largely expected to leave interest rates unchanged at 4.75 percent.

Range for this week: $1.8850-$1.9150