• Home ::
• Fundamental ::
• Market View ::
• FX Briefing

• Send
• Print
• Add To

FX Briefing

bebecc25-f6f9-4dec-a84c-08d64f591ab2

0

0

ECB admits that the economy is weakening

Mon, Aug 11 2008, 11:45 GMT
by BHF-Bank Economics Department

BHF-Bank

Highlights

• Q2 growth in eurozone and Japan set to be negative: recession could be looming

Dollar rebounds sharply

During the course of the week, the dollar strengthened against almost all major currencies. USD-JPY rose to nearly 110, whereas EUR-USD is now only around 1.51. The pound Sterling dropped by about 6 cents to 1.92. The Australian, New Zealand and Canadian currencies lost even more ground against the US dollar, as did the forint, zloty and the Czech koruna.

This had little to do with developments in the US itself: contrary to the fears of some market participants, the FOMC statement gave no indication of a hawkish bias. The movement was triggered by increasing concern about growth in the other industrialized countries and in emerging markets too. Despite the fact that prices are still rising sharply, interest rate cuts are no longer totally out of the question: the Australian central bank signalled an intention to do so, and the Czech central bank cut interest rates unexpectedly to 3.5%.

All the signs are indicating that economic growth in both the eurozone and Japan fell sharply in the second quarter. The relevant national data for both regions and Eurostat figures are due to be published next week. Furthermore, there is a strong possibility that the slowdown will continue in the third quarter, which could result in both regions falling into a recession (in the technical sense of two negative quarters).

In Japan, real GDP is expected to have fallen by about 0.5% quarter-on-quarter in Q2, mainly due to weak private consumption and negative net exports. Given that the index of coincident economic indicators has been below the critical level of 50 for four consecutive months in June, the government in Tokyo is now officially assuming that the country has “very probably entered a recession”.

In the eurozone, it looks as though Q2 2008 could be the first quarter with negative growth since the introduction of monetary union. Italy has been losing steam for some time, and the latest figures released this Friday showed that Italian Q2 GDP dropped by 0.3% quarter-onquarter. In Germany, which has recently been regarded as the main driver of growth in the eurozone, the picture could change even more drastically. We are now expecting real GDP to have plummeted by 0.7% quarter-on-quarter in Q2. If at the same time the Q1 growth rate is revised down somewhat, which we think is likely, the year-on-year growth rate might have fallen below potential. France and Spain will presumably have just managed to remain slightly above zero quarter- on-quarter. For the eurozone as a whole, we are expecting growth to have slowed to –0.2% quarter-on-quarter.

In the past months, the ECB had pointed out that there would be a negative technical reaction to the strong growth in the first quarter, which was caused by special factors. At last Thursday’s press conference, however, the central bank admitted that growth was slowing down more sharply and that this was not due to technical reasons alone. According to the ECB, weaker global demand, also in emerging markets, and high energy and commodity prices are the main factors dampening economic growth, and will continue to do so in the third quarter.

Given that the economic outlook has changed, raising interest rates in the eurozone is not likely to be on the cards. We are expecting the ECB to revise its growth projections down further in September. In view of falling oil and commodity prices, its assessment of inflation development is not likely to be revised significantly. However, this assessment sees prices falling slightly at first, and then more markedly in the fourth quarter. If economic growth remains weak, there could even be scope for interest rate cuts towards the end of the year.

In our view, the interest rate gap between the US and the eurozone is set to narrow. This would probably help to strengthen the dollar, which has been weighed down heavily by the credit crisis and its consequences. This is not likely to be a straight-line process: the dollar’s sharp appreciation movement over the last few days is actually crying out for a correction, at least a temporary one. But at the moment, the impending release of European and Japanese growth data is weighing on the currencies concerned.

• Download Full Fx Briefing

Published on  Mon, Aug 11 2008, 11:50 GMT