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Oil down, dollar up

Mon, Sep 8 2008, 06:25 GMT
by BHF-Bank Economics Department

BHF-Bank

Highlights

• Disappointing European economic indicators

• ECB lowers growth forecast, warns of second-round effects

EUR-USD hits lowest level this year

This week the euro dropped to 1.42 against the dollar, the lowest it has been this year. The pound Sterling also remained under pressure: cable slipped to 1.755 for a time – its lowest level since April 2006. The gloomy economic outlook is dragging the UK currency down. The OECD, for instance, sees Britain as the only G7 country which will slide into recession this year. The Bank of England has not yet reacted to this threat, keeping interest rates on hold at 5%. It could cut interest rates in the coming months, however. The yen, on the other hand, strengthened, rising to its highest level this year against the dollar. This was probably due to the unwinding of carry trades in view of the global downswing.

The weak economic data and falling oil prices continued to weigh on the euro. Hurricane Gustav spared the oil rigs in the Gulf of Mexico, causing the oil price to fall sharply at the beginning of the week. Once again, cheaper oil went hand in hand with a more expensive dollar. As the biggest oil importer, the US should benefit most from cheaper oil. Moreover, due to the drop in prices, commodities are becoming less attractive as an alternative investment. After losing 39% of its value since the beginning of the year, a large hedge fund, which had invested in commodity stocks and derivatives, was closed this week.

The economic data from the eurozone continue to be weak. Retail sales fell in Germany and the eurozone, and Q2 eurozone GDP components confirmed that private consumption has weakened significantly throughout the whole of the euro area: consumer spending has been stagnating since the 4th quarter of 2007. Furthermore, there are increasing signs that foreign demand is declining. German industrial new orders, for instance, dropped in July for the eighth time in a row; for the first time, orders from the noneurozone area declined more sharply too.

Markets were focused on the ECB press conference. Jean-Claude Trichet took a far less hawkish tone, however, than Bundesbank president Axel Weber, who had shocked markets the previous week by remarking that the ECB might have to consider raising interest rates towards the end of the year. Mr Trichet, however, insisted that the council had no bias.

The European Central Bank has become much more cautious in its economic assessment: although the council members regard the growth slowdown in the second and third quarter as only temporary, the uncertainty surrounding this outlook is particularly high in their view. Furthermore, there was no longer any mention in the introductory remarks of fundamentals in the eurozone being sound. The ECB staff lowered their growth projections accordingly: for this year, the experts are now expecting a central growth rate of 1.4% only (after 1.8% previously), and for 2009, they cut their forecast from 1.5% to 1.2%.

Although upside risks to price stability still prevail over the medium term, according to Jean Claude Trichet, he was confident that, after the last interest rate hike in July, eurozone inflation would be back on target in the course of 2010.
He emphasized that the governing council remains strongly committed to preventing secondround effects.

As from next February, the ECB is tightening lending rules for financial institutions using riskier collateral. Mr Trichet pointed out, however, that this was not a restrictive monetary policy measure, but rather a regular risk adjustment.

After the press conference, EUR-USD fell to fresh lows. Not many data are due to be published next week. Mr Trichet is unlikely to say anything different in his testimony to the European parliament on Wednesday. After having plummeted in the last few days, EUR-USD could calm down to some extent. However, there is still one important economic indicator outstanding this week – the US labour market report is due to be released later today.

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Published on  Mon, Sep 8 2008, 06:29 GMT