G10 Currencies
EUR: Why did the euro ease following the ECB press conference despite the fact that Jean-Claude Trichet gave a de-facto announcement of a rate rise in July? First of all initiall Trichet only delivered on what the FX market had expected in advance: “strong vigilance” as the announcement of a rate rise in July by probably 25bp, continued full allotment at the tender and a rise of the inflation projection for 2011. So time for all those who had betted on these comments and bought the euro ahead of the meeting to take profits as an initial reaction – after all there was nothing more hawkish to follow.
The fact that Trichet was very clear and unshakable regarding the ECB’s position on collateral rules was decisive in the end, though. Trichet stuck to the fact that the ECB would no longer accept Greek bonds as collateral in case of a default or a restructuring and that this was “crystal clear”. As a result the uncertainty surrounding Greece remains high. Moreover the ECB’s attitude served to once again illustrate the rift between the central bank and German politicians to the market. The euro was unable to avoid this drag causing EUR-USD to ease below 1.45. The fact that the ECB left the inflation outlook for 2012 unchanged at 1.7% was the final straw: speculation that the ECB might act more cautiously medium term increased on the FX market.
Thanks to its steadfast attitude regarding the collateral rule – in addition to the decisive defence of price stability over the past few months – the ECB’s credibility improved considerably. This is likely to benefit the euro long term. Short term uncertainty kept the upper hand on the market, though: the Greece issue remains acute, an agreement seems very difficult and fears of a default were not allayed. The market is unlikely to change its view ahead of the weekend. The main event of the week is behind us, profits have been taken. As a result the euro is likely to start the weekend in a battered position; due to a lack of important economic data on either side of the Atlantic there is a lack of fundamental momentum with sentiment remaining the main driver. And the latter is euro-negative at present.
GBP: Yesterday as expected the BoE left interest rates on hold at 0.5%. There was no change in the asset purchase program either, meaning the BoE is not going to engage in further quantitative easing at least for the time being. The decision was already priced in, meaning on the day there was no immediate reaction in GBP. Data releases over the last number of months have been poor and this is unlikely to change in the coming months as consumers are faced with increasing energy bills and an uncertain labour market. The BoE in our opinion is unlikely to increase interest rates until such time as it sees clear evidence of economic recovery and can only do this following data releases from Q2 and Q3. This suggests the November meeting is pivotal in this regard. Today we will get industrial production and manufacturing numbers at 9:30 am UK time. Levels to watch in EUR-GBP on the downside are 0.8820 and 0.8930 on the upside.
CAD: Despite the general dollar weakness the CAD has been an underperformer for the past two weeks (see chart). That is rather surprising from a fundamental point of view, since growth in Q1 was robust and the May PMI had risen to an impressive 69.1 points. Moreover the Bank of Canada had sounded far less cautious in its statement of late May, a fact that at least caused the test of the 0.9650 area in USD-CAD back then. We expect the rate rise cycle in Canada to be resumed in Q3, so well ahead of the Fed. Nonetheless: if markets begin to doubt the recovery of the US economy the CAD is immediately tarred with the same brush. As a result the loonie has recently been unable to benefit from the dollar weakness to the same extent as other currencies. Today’s labour market report for May from Canada is unlikely to change that as markets punish the CAD for the weaker than expected US economy rather than taking into account Canadian data. But a positive labour market report might at least cause a breach of the 0.9720 mark in USD-CAD.
Emerging Market Currencies
CZK: At 2.0% yoy May’s inflation rate published yesterday came in above consensus expectations of 1.8%. However, the Czech koruna was not able to appreciate against the euro and the US dollar on a sustainable basis. The fact that the gains were not more pronounced was mainly due to the fact that the rise of the inflation rate is unlikely to have an effect on the Czech central bank’s (CNB) monetary policy. In its current inflation outlook the CNB expects the inflation rate to climb above its target of 2% over the coming months anyway. So there is no scope at present for excessive rate hike and appreciation speculation.
MXN: The Mexican central bank can continue to sit back and relax as there is no sign of price pressure in Mexico. In May inflation eased to 3.25% and thus remains comfortably within the central bank’s target corridor of 2-4%. So there is still no need for the Banco de Mexico to raise its key rates this year. Today’s minutes are likely to confirm this. The moderate inflation data was unable to put pressure on the peso. A first rate step is some way off anyway and already priced in by the markets. Instead the peso was able to benefit from the improved market sentiment. As there is no important economic data due for publication external factors are likely to dominate once again today.
BRL: Today’s retail sales for April are likely to demonstrate that demand in Brazil might have cooled down slightly but continues to develop solidly thus providing an important contribution to GDP growth. Price pressure remains high and as a result the Brazilian central bank is likely to continue its rate hike cycle. Following its rate hike to 12.25% yesterday it had signalled that there won’t be a break in the rate hike cycle yet. We expect to see two further rate steps by 25bp each during the next two meetings. The monetary policy tightening is likely to support the real, but external factors such as the debt crisis in the euro zone or concerns about US growth might allow USD-BRL to temporarily trade above the 1.60 mark though.
CNY: China’s trade balance for May showed a trade surplus US$13.05bn, down from US$11.42bn the month prior, but less than expectations of US$19bn. Export growth slowed in line with expectations to 19.4% y/y, while import growth accelerated unexpectedly at 28.4% y/y. The stronger than expected imports show that the Chinese economy is not slowing to the extent feared by many in the markets. The strong import data is evidence of a relatively strong economy and is positive for the CNY. Next week we have the all-important CPI data for May.
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