Highlights

  • Fed representatives emphasise “exceptionally low interest rates for extended period”

  • Winter weather affects economic data in USA and Europe

  • Rating agencies threaten to downgrade Greece further

  • ECB set to discuss further steps to normalise money market conditions


Euro falls to 12-month low against yen

The dollar remains on a firm footing. In spite of attempts by US central bank chairman Ben Bernanke and his colleagues to dampen rate hike expectations triggered by last week’s increase in the discount rate by repeatedly stating that interest rates would remain “at exceptionally low levels for an extended period”, EUR-USD slipped to below 1.35 temporarily. Towards the end of the week, however, EUR-USD recovered somewhat to almost 1.36. The dollar thus relinquished its gains again.

At first glance, this week’s US economic data painted a mixed to gloomy picture. Market participants were particularly shocked by the sharp drop in consumer confidence in February (from 56.5 to 46.0) and new home sales plummeting to a record low in January. Initial jobless claims also rose to almost 500,000. But the adverse weather conditions had probably had a negative effect on the figures, which is why they had relatively little impact on the forex market.

The markets were more affected by the drop in the ifo business climate index. It only fell moderately, however, from 95.8 to 95.2. Moreover, the decline was primarily due to a deterioration in the assessment of the current situation, particularly in the wholesale and retail sectors. The expectation components actually improved marginally. This indicates that snow and ice played a major role here too. Markets were particularly concerned that the upward trend of the past ten months had been interrupted – especially as EU Commission survey data for the eurozone painted a similar picture.

The string of negative reports about Greece put the euro under additional pressure. A fresh national strike shows that there is still considerable political resistance to the government’s budget cuts. Furthermore, the biggest Greek banks were downgraded, and the rating agencies S&P and Moody’s indicated that they may make further cuts to Greece’s credit rating. S&P, whose rating of BBB+ is two notches below Moody’s, referred to downside growth risks. Moody’s, whose rating for Greece is still A2, called for tangible progress in stabilising public finances.

The yen was the clear winner of the week in the forex market. During the course of the week, USD-JPY fell by over two yen to 89; EUR-JPY dropped by three yen to 121.30. On Thursday, EUR-JPY actually hit a 12-month low at 119.66. According to traders, the movement was triggered by some large Japanese exporters, apparently worried that the euro could fall even further, selling euros. The transactions are said to have sparked stop-loss orders which in turn accelerated the euro’s slide.

The movement was probably prompted by perceived risks for the eurozone. But Japan’s economy is looking remarkably robust at the moment too. Industrial production rose in January by a whopping 2.5% month-on-month, after increasing by 1.9 and 2.2% the previous months. At the present level, production is thus already 4.5% above the average for the fourth quarter. The trade surplus also increased significantly; from December to January, exports and imports rose by more than 8% respectively.


ECB: Further steps towards normalising money market conditions

Next week, the ECB will discuss whether and to what extent the extraordinary monetary policy measures still in operation can be phased out.
The last 12-month tender was held in December, and the 6-month tender being held at the end of March is to be the last one. The next step is likely to be reverting to variable rate tenders for refinancing operations with a maturity of 1 or 3 months. Full allocation at the refinancing rate will probably only apply to the weekly tenders in future.

It will be interesting to see whether the ECB gives, or hints at, a specific time frame for reverting to “normal money market conditions”. The excess liquidity in the money market could disappear at the beginning of July, when the €442bn 12-month tender matures. Then, if adequate liquidity is no longer available, money market rates are likely to shoot up.

The ECB staff projections are also on next Thursday’s agenda. We are not expecting any significant changes from December’s estimates.
The inflation forecast could turn out to be slightly lower, however.

In view of the problems with Greece and the fact that the recovery in the eurozone appears to have stalled, markets have priced out expectations of interest rate hikes to a large extent. If, however, the ECB comes up with a precise plan to normalise money market conditions, interest rates could rise sooner than expected, without a shift in monetary policy. Thus if there are any surprises in store, they are fairly certain to be on the side of higher rates, which ought to support the euro, at least for the time being.