US Dollar Rallies - But Where Was the Fed?

Published August 18th, 2008 - 06:31 GMT

The US dollar extended its recent gains this week, breaking through some key levels against its main counterparts. Although it was helped by some supportive US figures, it was the weaker tone of data from other economies that may have again provided the main impetus. Sterling saw the sharpest fall, £/$ down to 1.8512 (lowest since July 2006), after a downbeat assessment of the UK's prospects by the Bank of England. The Bank's latest Inflation Report raised speculation of a recession and lower interest rates, in spite of data showing CPI inflation rose to a decade high in July. €/$ dropped below 1.50 for the first time since February and extended its losses to 1.467 after confirmation of
the first fall in euro zone output since the euro was introduced in 1999. Japanese GDP contracted by an annualised 2.4% in the second quarter, helping send $/Y through 110.50. The Australian dollar remained under downward pressure this week on the growing prospect of lower interest rates and weak commodity prices. Crude oil fell below $112, down by almost 25% from its record high last month. In emerging markets, Eastern European currencies remained under downward pressure and there was also a sharp fall in the South African rand.

Trevor Williams, Chief Economist at Lloyds TSB Financial Markets



Weekly Bank Research Center 08-18-08

 

A Poor Summer Scorecard

Stephen Roach, Head Economist, Morgan Stanley

As we are closing the books on the second quarter and opening them for the third, the euro area economy seems to be scoring poorly. The second quarter marks the first outright contraction in euro area GDP since the start of the EMU. In this note, we look at the growth score for the euro area and discuss the updated outlook for growth, inflation and interest rates in the remainder of this year. Incoming data induce us to slightly tweak our estimate for this year, but to leave the forecast for next year unchanged. Based on the slightly larger contraction in 2Q GDP, a slight downgrade to our 3Q and 4Q GDP estimates, and a downward revision to past data, we lower our full-year 2008 forecast to 1.3%, from 1.4% previously. For next year, we reiterate our below-consensus estimate of 1%. It probably will take until late this year or even early next year before signs of a recovery materialise in the monthly and quarterly data. Hence, the debate about the euro area heading for a recession is unlikely to die down any time soon. While a technical recession is not our main case, we certainly cannot rule out another negative quarter, given the usual standard error around such estimates.

 

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Bank of England Softer Than Expected

Niels-Henrik Bjørn Sørensen, Senior Analyst, Danske Bank

The Bank of England (BoE) released its August Inflation Report on Wednesday 13 Aug. As expected, the BoE revised its growth path downwards and the inflation path upwards compared to the May Inflation Report. Although such revisions were generally expected, markets were surprised by how negative the report was and also how downbeat BoE Governor Mervyn King was at the press conference afterwards. Market reaction to the Inflation Report was quite strong: EUR/GBP rose from 0.7860 to 0.7930, before falling slightly back, and the yield on the 2Y UK gilt dropped around 15bp to 4.52%. These movements were significant, as reaction to the May report, which also had a concerned tone and some controversial content, was rather limited. In our view, the Inflation Report depicts a pretty fair picture of the challenges confronting UK policymakers. Growth prospects are unusually bleak due to the downturn in house prices threatening to suppress consumption, but the BoE cannot justify resuming the easing cycle while inflation is soaring. However, as soon as inflation has peaked and starts coming down to more tolerable levels, the BoE can again cut rates. Accordingly, we expect the BoE to lower the base rate to 4% by end-09 (base rate currently 5%) to stimulate the economy and to ensure that inflation does not undershoot its target. Our outlook of GBP underperformance remains intact. We expect EUR/GBP will return to territory above 0.80 (GBP/DKK below 9.32), though higher (lower) levels cannot be ruled out when the magnitude of the slump in the UK economy becomes clearer.

 

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Consumer Prices: Temporary Peak? How Much Decline Ahead?

E. Silvia, Ph.D. Chief Economist, Wachovia

Recent oil price declines were seen as helping the consumer, reducing the downside risks to the overall economy and helping financial asset prices. Not so with the latest consumer price data. Inflation is clearly at problematic levels. The Consumer Price Index rose 0.8 percent in July, while headline CPI is now up 5.6 percent year-to-year. Meanwhile, core CPI, excluding food and energy items, rose 0.3 percent and is up 2.5 percent year over year. Persistent inflation is a hit to real household incomes. Slower economic growth has not led to lower inflation as many analysts had expected. Moreover, the extent of any decline in inflation may still leave the pace of inflation above that consistent with current financial asset prices. One odd observation in the data is that food at home is now more expensive than food away from home. The price of chicken on the grill is going up faster than chicken at our favorite fast-food place. If this keeps up, it could become cheaper to go out to eat than to fix dinner at home.

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Death of the Dollar Has Been Greatly Exaggerated

Steve Chan, Economist, TD Bank Financial Group

Putting aside the forecast risks, the latest news of higher inflation in the US has markets pricing in a higher risk interest rates could march higher. This has three effects, all negative for oil prices. Higher interest rates mean even less U.S. consumer demand. Strike one for oil. Higher expectations for interest rate increases from the Fed tend to mean a stronger U.S. dollar, which markets have used as shorthand for shorting oil. Strike two. Lastly, the fact that the U.S. dollar has appreciated by about 5-10% against most emerging market and major currencies in the last month means oil prices elsewhere have either fallen less or not at all – especially after you account for falling subsidies in many emerging markets. Strike three. As a result, oil prices – with many other commodities – haven’t just come off the boil, they’ve spilled all over the floor.

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Dollar Rally Continues

Trevor Williams, Chief Economist at Lloyds TSB Financial Markets

The US dollar extended its recent gains this week, breaking through some key levels against its main counterparts. Although it was helped by some supportive US figures, it was the weaker tone of data from other economies that may have again provided the main impetus. Sterling saw the sharpest fall, £/$ down to 1.8512 (lowest since July 2006), after a downbeat assessment of the UK's prospects by the Bank of England. The Bank's latest Inflation Report raised speculation of a recession and lower interest rates, in spite of data showing CPI inflation rose to a decade high in July. €/$ dropped below 1.50 for the first time since February and extended its losses to 1.467 after confirmation of the first fall in euro zone output since the euro was introduced in 1999. Japanese GDP contracted by an annualised 2.4% in the second quarter, helping send $/Y through 110.50. The Australian dollar remained under downward pressure this week on the growing prospect of lower interest rates and weak commodity prices. Crude oil fell below $112, down by almost 25% from its record high last month. In emerging markets, Eastern European currencies remained under downward pressure and there was also a sharp fall in the South African rand.

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Compiled by David Song, Currency Analyst

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