US rates still heading higher

Euro

Political pressure on the ECB to cut rates is rising, as finance ministers from the euro zone are demanding a bigger say in policy decisions as their economies struggle.

The dollar held firm against the euro at the start of the week, riding high on the back of upbeat comments by the Fed Chairman Alan Greenspan. He stated that the U.S economy was on a 'firm footing' and suggested interest rates still had room to rise.

In contrast, the euro zone's sluggish economy is raising expectations that the European Central Bank's next move may be an interest rate cut. A weekend interview given by ECB Chief Economist Otmar Issing added fuel to these expectations after he said risks to price stability had decreased.

Data showed that U.S producer prices fell a steeper-than-expected 0.6 percent in May, the biggest drop in two year, while retail sales fell 0.5 percent last month, the largest decline in nearly a year.

However, the dollar ignored the weak data and touched new nine-month high of $1.2014 against the euro on the belief that the U.S economy would continue to outperform the euro zone.

Furthermore, the dollar found support from the latest round of comments by the Fed officials. St. Louis Fed President William Poole said that low inflation and anchored inflation expectations gave the central bank room to 'use monetary policy more aggressively'.

Richmond Fed President Richard Lacker said it was too early to say when policy makers would be done tightening monetary conditions. As the week progressed, the dollar lost ground versus the single currency after the release of more weak data.

The U.S. Net capital inflows totalled $47.4 billion in April, compared with a revised $40.6 billion in March, while the U.S. trade deficits in April and March totalled $57 billion and $53.6 billion respectively. The dollar was also kept under pressure after 0.1 percent fall in U.S consumer price index (CPI) in May.

At the end of the week, the dollar extended its losses after news that the U.S. current account deficit widened to a record $195.1 billion in the first quarter. The deficit, running at a record 6.4 percent of GDP, was wider than the $190 billion forecast by economists. The deficit in the fourth quarter of last year was also revised to a slightly wider $188.36 billion.

The data highlighted the extent to which the U.S. needs to attract large inflows of foreign capital to fund the deficit and are a reminder to traders of the dollar's structural weakness.

Meanwhile, dollar couldn't get support from the University of Michigan's preliminary June consumer sentiment index, which rose to 94.8 from 86.9 in May. Economists had expected a reading of 89.0.

Next week financial markets would keep a close eye on German investor confidence data. A weak reading would renew pressure on the European Central Bank to cut interest rates to boost sluggish growth.

Range for this week: $1.2140-$1.2440

Yen

Japanese yen tumbled against the dollar at the beginning of the week as traders shrugged off a meeting of G8 finance ministers and focused on the prospect of more rises in U.S interest rates.

The finance ministers of the Group of Seven industrialised nations plus Russia (G8) kept up pressure on developing Asian economies to adopt market-based exchange rates. However, the meeting produced no clues as to when China will relax the peg of its currency to the dollar, a move many analysts expect would buoy other Asian currencies including the yen.

Furthermore, the G8 did not release a formal communiqué on foreign exchange. Japanese yen came under additional pressure after data showed that Japanese economy expanded by 1.2 percent compared to the original estimates of 1.3 percent.

As the week progressed, the Japanese government upgraded its assessment of Japan's economy for the first time in nearly a year, helping the yen recoup earlier looses from a low of 109.71 per dollar.

Range for this week: Y107.00-Y110.00

Sterling

At the start of the week, sterling fell to its lowest level in eight months against the dollar weighed by a strong U.S currency and weak UK price data.

British factory gate inflation slowed to its weakest rate in three months in May despite an unexpected rise in raw materials' costs, signalling another decline in manufacturers' pricing power.

Separate official government figures showed British house price inflation fell to its lowest rate in almost four years to 6.9 percent year-on-year in April from 12.6 percent in March.

As the week progressed, the pound managed to find some support after BoE Governor Mervyn King said that policy makers had to balance the market slowdown in consumer spending against various upside risks to inflation, dashing hopes of an imminent rate cut.

Furthermore, data showed that Britain's inflation rate stayed at a seven-year high just below 2 percent in May, boosting expectations that interest rates would stay on hold for now. Furthermore, sterling shrugged off surprisingly poor UK economic data.

The number of Britons out of work and claiming benefits rose by 13,200; more than the 5,000 expected, while April's rise was revised up to 10,800. British retail sales in May marked their weakest annual rise in more than six years, in another sign that consumer spending is slowing fast.

Next week, markets will focus on the minutes of the Bank of England May meeting, at which the Bank left rates unchanged at 4.75 percent. The real interest will be on whether any MPC members viewed the current softness in consumer indicators as a reason to consider cutting interest rates.

Range for this week: $1.8160-$1.8460