by Darrell Jobman, Editor-in-Chief TraderPlanet.com
The dollar found strong support close to 1.4650 against the Euro early on Friday and then strengthened sharply over the day. The rally was given additional fuel by strong US inflation data and the dollar pushed to highs near 1.4415 in US trade. This was the strongest daily gain against the Euro for over two years while the dollar’s trade-weighted index also rose strongly.
Headline US consumer prices rose 0.8% in November as energy prices pushed higher while the core increase was also larger than expected at 0.3%. The annual inflation increase rose to a strong 4.3% which is comfortably the highest level for the year while the core annual increase also rose to 2.3%. Although driven by energy prices, inflationary pressure will be a significant market feature in the short term and will make it more difficult for the Fed to cut interest rates.
Futures marketscut the chances of a January interest rate cut but, given that the chances are still put at over 80%, there will be scope for some further adjustment of expectations which will provide some further short-term dollar support.
The November Euro-zone inflation rate was revised up to 3.1% from the provisional 3.0% which was a six-year high for the headline rate. The inflation fears will be countered to some extent by the drop in the core rate to 1.9% from 2.0%, but the ECB will remain on high alert over the inflation situation and Euro retreats will strengthen their case for a further interest rate increase.
The yen was unable to regain the 112.0 level against the US currency during Friday and weakened steadily as the US currency secured wider gains. The dollar pushed to a six-week high around 113.40 with the Japanese currency testing longer-term support levels, although it held its ground against the Euro. The quarterly Tankan industrial survey weakened to 19 in December from 23 previously which will tend to undermine confidence in the Japanese economy and will continue to curb any speculation that the Bank of Japan will move to tighten policy in the short term. The capital spending plans were, however, increased which will offer some yen support.
The yen should also still gain some protection from unease over credit-market trends and weakness in banking stocks as further debt write-downs are announced. Volatility levels will remain higher in the short term.
Sterling was influenced strongly by dollar trends on Friday and robust gains by the US currency pushed Sterling to lows below 2.02 against the US currency. In contrast, Sterling secured further progress against the Euro with gains to around 0.7140.
Domestically, MPC member Barker aimed to dispel excessive pessimism over the UK economy and made no detailed remarks on interest rates. She also stated that manufacturing would benefit from a weaker Sterling trend which unsettled the currency slightly.
The UK retail sales and consumer inflation data, together with the MPC minutes from December’s meeting, will be watched very closely next week. The tone of these reports will be very important for near-term interest rate expectations and the possibility of back-to-back rate cuts.
The Swiss currency made some headway against the Euro on Friday with a move to around 1.6640, but the Swiss currency was firmly on the defensive against the US dollar. The franc weakened to around 1.1550 against the US dollar which was the lowest level since early November before securing a slight recovery.
The Australian dollar was unable to push back above the 0.88 level on Friday and weakened sharply to lows just above the 0.86 level before stabilising as the US dollar secured broad gains.
The domestic trends remained limited on Friday and the Reserve Bank minutes from December’s meeting will be watched closely next week for further evidence on potential 2008 interest rate policy.
The more positive US currency sentiment will continue to curb Australian dollar demand initially, although the impact of the credit crunch and fears over global growth will represent bigger overall risks. The local currency will also tend to be unsettled by fears over a further decline in industrial commodity prices.