Euro sentiment under the hammer

Euro

The euro's slide against the dollar continued through the week after the rejection of the European Union constitution by France and Netherlands, sent the single currency plunging down.

The uncertain outlook for further European political and monetary integration along with the region's poor growth prospects all helped drive the euro down. The 'no' votes on the proposed constitution have even stirred speculation about the future of the eurozone's monetary union, which underpins the single currency and central bank.

Midweek, the euro found some respite against the greenback on profit taking and on markets interpretation of comments made by Fed Chairman Alan Greenspan to mean the Fed may soon pause in raising official interest rates.

Greenspan, who took part in the Beijing conference via video link, said that 'new forces' were keeping long-term interest rates low and this situation was unlikely to change soon.

Meanwhile comments from ECB President Jean-Claude Trichet that he was not preparing for a rate cut, easing concerns that the ECB may lower rates to help kick start a sluggish economy, also helped cushion the euro.

The dollar however gained momentum and surged to a fresh nine-month high of $1.2107, after narrower-than-expected U.S. trade deficit data eased concerns about the financing of the world's largest economy.

The U.S. trade gap widened to $56.96 billion in April, the fourth widest on record, compared with forecasts of $58.0 billion. Meanwhile, Greenspan in his testimony to the joint economic committee of the Congress stated that the Fed has no plans of abandoning its measured pace of rate hikes ending earlier speculation of a pause in the Fed's rate hiking cycle.

The Fed has raised short-term borrowing costs eight times since last June to 3 percent in a bid to head off inflation. That contrasts with the eurozone, where rates have been stuck at 2 percent since June 2003, with many speculating the next move by the ECB could be a rate cut.

In the coming week, U.S. inflation and capital flows data are set to take centre stage. In a series of high level meetings, European leaders and finance ministers are expected to put a brave face on what has been a disastrous fortnight for the euro and aspirations for greater EU integration.

Range for this week: $1.2000-$1.2300

Yen

The Japanese yen held firm at the onset of week, supported by hopes of a possible revival of speculation that China will soon relax the yuan's peg to the dollar, a move that many see buoying the yen.

China's central bank chief stated that Beijing was determined to reform its forex regime, while reiterating that outside pressure for a revaluation of the yuan would not make it happen sooner. China's economy and its currency will likely be discussed this weekend at a meeting in London of the finance ministers of the eight leading industrialised nations.

Meanwhile, a report in the Financial Times which suggested several foreign companies might pull out of Japan if proposed changes to the country's commercial code, which would increase their cost, go through, also added pressure on the yen.

In Japan, the central bank will hold a two-day monetary policy meeting from Tuesday, but is not expected to signal moves towards ending its ultra easy monetary policy.

Range for this week: Y106.50-Y109.50

Sterling

Sterling hit its highest level in almost three weeks against a waning dollar and a 10-month high versus the euro, helped by EU budget wrangling and a narrower-than-expected U.S. trade gap.

Britain threatened to veto any moves to end its annual EU budget rebate, worth over 4.6 billion euros ($5.63 billion). The spat comes ahead of a summit on the EU's long term finances next week.

Meanwhile, a recent run of gloomy data has fuelled expectations for a cut in the cost of borrowing, which many analysts predict, could come sometime in autumn. The Bank of England kept rates unchanged at 4.75 percent for the tenth month running on Thursday.

Week ahead, markets will keep a close watch over the inflation data which includes the Producer Price data for May on Monday and the Consumer Price index on Tuesday, for clues on the direction of UK interest rates.

Range for this week: $1.8000-$1.8300