The Dollar may reverse its weakness says Bank of America and Merrill Lynch

The dollar is poised to reverse declines because the outlook for inflation is being exaggerated, according to Banc of America-Merrill Lynch. “The dollar has continued to weaken over the past few weeks, but the reason now appears to center on rising inflation risks, rather than on growth alone,” Daniel Tenengauzer, head of foreign-exchange strategy in New York, wrote in a research report today. “We still expect dollar weakness to eventually reverse rather than go off on a more extended secular broad- based decline, even as markets have recently moved against our forecasts, based on our skepticism of the dismal inflation outlook that markets expect.” The EUR/USD is currently trading at $1.4230 as of 8:33am, London Time.

Sterling fell sharply against the dollar on Wednesday, erasing earlier gains which had propelled it to a 7-month high as the U.S. currency recovered after Asian monetary officials said they would keep buying U.S. Treasuries. Weak U.S. employment and services sector data also stung optimism on the global economic outlook, further helping the dollar against higher risk currencies such as sterling. The deteriorating market sentiment prompted investors to dismiss earlier surprisingly strong UK services sector data, which had lifted sterling against the euro before turning lower later as UK shares tumbled 2.3 percent. A worsening political crisis for UK Prime Minister Gordon Brown also helped take some shine from sterling as Communities Secretary Hazel Blears became the latest high profile minister to tender her resignation from the government. The GBP/USD is currently trading at $1.6360 as of 9:00am, London Time.

European Central Bank President Jean- Claude Trichet’s efforts to heal an unprecedented rift among policy makers may be aided by signs of an economic recovery. Even as policy makers bicker over the extent of asset purchases, the ECB is unlikely to signal it will buy more than the 60 billion euros ($85 billion) of covered bonds it has already announced, economists said. The Frankfurt-based ECB will today also keep its benchmark interest rate at a record-low 1 percent, according to 52 of 54 economists in a Bloomberg survey. The bank announces its rate decision at 1.45 p.m. and Trichet will unveil details of the covered-bond purchases at a press conference 45 minutes later. Investors will be looking for information on the types of covered bonds to be purchased.

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