by Darrell Jobman, Editor-in-Chief TraderPlanet.com
The dollar found support close to 1.3540 against the Euro on Wednesday and challenged levels below 1.35, but was unable to break 1.3490 and consolidated close to the 1.35 level.
The Euro was undermined slightly against the dollar by losses against the yen and Swiss franc as there was some move to curb carry trades as stock markets weakened.
As expected, the ECB increased interest rates by 0.25% to 4.0% following the latest council meeting. In the press conference following the decision, ECB President Trichet stated that there were still upside inflation risks, but that the rate increases already sanctioned were having an impact.
The ECB raised the 2007 inflation forecast slightly, but left 2008 inflation forecasts unchanged. The stance overall suggests that the bank will maintain a tightening bias and is expecting to increase rates again. The ECB appears in no rush to tighten again, especially as no meeting is scheduled in August. The main problem for the Euro is that the markets have already priced in further increases which will limit the potential for further buying.
There were no major US releases, but there was an upward revision to first-quarter unit labour costs to 1.8% from the previous estimate of 1.3% which will maintain expectations of steady interest rates.
The Japanese yen found support close to the 121.50 level against the dollar, strengthening to 121.0, and the Japanese currency also strengthened to highs around 163.30 against the Euro.
Japanese bond yields have increased with 2-year interest rates rising to above the 1.0% level for the first time in 10 years. The direct benefit to the yen will be offset by the fact that overseas yields are also rising, but rising interest rates will still have an important impact as global stock markets will tend to weaken.
There is some evidence of greater caution over carry trades which should stem yen selling pressure. There is also still a risk of a more disruptive correction in carry trades, especially if global stock markets weaken, which would push the yen sharply stronger.
Sterling found support close to 0.6790 against the Euro and recovered back to 0.6765 in US trade as the Euro drifted weaker. Sterling encountered further selling pressure above the 1.9950 level against the dollar, but resisted a decline through 1.99.
Consumer confidence rose strongly to 99 in the latest Nationwide survey from 90, although spending intentions were weaker. The latest KPMG wages survey also recorded an increase in settlements to a 7-year high which will reinforce expectations of further UK interest rate increases, although earnings evidence overall has been mixed.
The Bank of England will still have a tightening policy bias, especially as recent inflation surveys have been generally firm. There has, however, been evidence of a slowdown in consumer spending over the past few weeks. The most likely outcome is that the MPC will hold rates unchanged on Thursday, although there is the possibility of an increase and the UK currency will jump stronger if there is a rise to 5.75%.
Sterling trends will continue to be correlated with carry trade developments and global stock market trends. Any wider increase in risk aversion would tend to weaken the UK currency as high-risk positions are scaled back.
The Swiss currency remained robust against the Euro on Wednesday, strengthening to highs around 1.6425 in US trading. Consequently, the dollar was unable to make any headway against the Swiss franc and settled close to 1.2165.
The ECB stance was not quite as restrictive as had been feared and this will offer some franc support within Europe, especially as there will be speculation that the National Bank could increase interest rates by 0.5% at next week’s council meeting.
Carry trade considerations will remain very important and the Swiss currency will gain further support if there are sustained declines in global stock markets and fears over a liquidity squeeze.
After a brief correction, the currency strengthened again in local trading on Wednesday with a 17-year high close to 0.8440. The Reserve Bank of Australia left interest rates unchanged at 6.25%, but the currency was boosted by a stronger than expected increase first-quarter GDP increase of 1.6%. The data reinforced confidence in the economy and expectations that the central bank could tighten monetary policy again over the next few months.
Confidence should remain firm in the short term with further interest in high-yield currencies, but there has been some evidence that carry trades are being unwound and this will tend to curb Australian dollar buying support.