Euro plunges from 1.49 to 1.45 EUR/USD on “postponement” of the next rate hike by Trichet: 1.50 more remote for some time. Wednesday’s inflation report will be key for GBP. The simple breaching of 80.00 USD/JPY is not enough to trigger BoJ action..…
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EUR – Umpteenth confirmation of how at this time it is rates expectations that drive forex exchange rates. In just one day EUR plunged from 1.4900 to 1.4510 EUR/USD, since at the end of yesterday’s ECB meeting Trichet hinted that having already lifted rates last month, another rate hike as early as June is not so urgent now. We have left our 1m projection at 1.50 since we still expect a rate hike in July. But before then, in the ultrashort term, a bounce to 1.50 looks unlikely, and the exchange rate is more likely to trade in range with fluctuations mainly concentrated between 1.44 and 1.47. The Euro area GDP data due next week will be key, and they should show an acceleration in 1Q11. This should help EUR recover, but only partially. On the contrary, in the case of worse than expected growth, the euro would suffer a larger fall.
GBP – Sterling lost last week’s gains vs. USD, falling from 1.67 to 1.63 GBP/USD. The correction was triggered by a slew of unexpectedly very negative data, notably the April PMI. The April data are important since they refer to the start of 2Q11 and as such should give a more accurate idea of the state of, and outlook for, the UK economy. The 1Q11 GDP data have already been released, but the advance estimate of +0.5% qoq after -0.5% in 4Q10 was not sufficient to indicate that the economy is recovering. As for the Bank of England, it left both the bank rate and the APF unchanged again this month. The inflation report due next Wednesday will be very important. If, in light of the recent data (economic activity data not encouraging and latest inflation figure surprisingly down), the BoE were to revise down the growth and/or inflation projections, even only for a portion of the forecasting horizon, GBP would continue its downtrend towards 1.62-1.60 GBP/USD. If on the other hand the BoE revises up the growth profile, even for only a portion of the time horizon considered, GBP would match/pass the recent high at 1.67 GBP/USD. Overall, the latter of the two alternatives looks far less likely. In our view the BoE is more likely to leave the growth and inflation profiles unchanged, signalling perhaps that the inflation risks, though still to the upside, might be slightly diminished compared with three months ago. In this case sterling would correct, notably vs. USD.
JPY – This week too JPY continued to rise vs. USD, bringing the USD/JPY exchange rate from 81 to 79. We do not believe the breaching of 80.00 USD/JPY would automatically trigger direct intervention on the forex market to halt the firming of yen. The situation is very different from the earthquake scenario: in that case intervention was justified by the violence of the movement and the exceptional nature of the event (not by the level of JPY). In addition, the exchange rate continues to be driven by the comparison between US and Japanese short-term yields, with the former still falling and the latter steady. Given the limited scope for further falls in US yields, and the basically zero probability of a rise in Japanese yields, JPY should not linger long at robust levels and between 80.00 and 78.00 the BoJ should not intervene. The downward reversal in JPY has still to materialise but it is drawing ever closer.
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