The EUR/USD and the USD/JPY both fell back from 2-month highs to start
this week's trading. Traders are cautious at these levels after the
sparkling 2-week rally. Investors have been focusing on the steps
being taken by European officials to move beyond the current status
quo when it comes to the precarious condition of Portugal and even
Spain in the sovereign debt crisis.
There has been talk of expanding the role of the EFSF (European
Financial Stability Facility) rescue fund - either by letting troubled
countries retire debt early using its funds or allow the facility to
buy sovereign debt (government bonds) of troubles countries - similar
to what the ECB has been doing (to the tune of 73 billion euros by
this point).
These recent talk and the more determined statements by key financial
officials - Ollie Rehn, Axel Weber - saying that a deal will be done
very soon has excited the markets to this point. Now where do we go
from here?
*ECB Getting More Cautious on Inflation*
European Central Bank President Jean-Claude Trichet warned in a Wall
Street Journal interview that the central bank is prepared to respond
to inflationary pressures with higher interest rates, despite economic
weakness in Greece and Ireland. But he also said that the ECB will not
overreact to temporary inflation pressures driven by higher commodity
prices. The ECB will look for "secondary knock-on" effects like
increasing wages.
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TRICHET: We are profoundly attached to our mandate. And that explains
the solid the anchoring of our inflation expectations, which we see as
one of our major assets because it helps avoiding second round effects
when we have oil price increases in particular. Clearly, in particular
on the side of energy and commodity prices we have a number of
developments that we will continue to monitor closely.
WSJ: Tighter monetary policy would have the biggest impact on
countries like Spain, Greece and Ireland where private debt is linked
to Euribor. Can you understand why those peripheral countries are
concerned about this hawkish shift?
TRICHET: I also said in my last press conference that the present
interest rates were appropriate. In any case all countries in the euro
area have an immense stake in the solid anchoring of inflation
expectations because medium and long-term interest rates incorporate
future inflation expectations.
WSJ: Inflation is being driven by energy and commodity prices and
higher value-added taxes in some countries. Is the ECB's focus on
headline inflation misplaced? Does the Fed have it right by focusing
more on core inflation?
TRICHET: In the U.S. the Fed considers that core inflation is a good
predictor for future headline inflation. In our case we consider that
core inflation is not necessarily a good predictor for future headline
inflation. That being said all central banks, in periods like this
where you have inflationary threats that are coming from commodities,
have to go through the hump and be very careful that there are no
second-round effects. This is what we are doing.
WSJ: When you hiked rates in 2008 there were signs of those
second-round effects. Do you see evidence they are starting to take
hold in Germany or elsewhere?
TRICHET: At this stage, we do not see this. And everybody knows we
would not let second-round effects materialize. We will continue to
deliver price stability.
Still, Trichet's comments reinforce the more hawkish tone of the ECB
that first emerged earlier this month - after annual CPI rose above
2%.
Macro-economic data was largely positive from Europe, with activity in
Germany's private sector accelerating to another four-and-a-half year
high, while euro-zone private sector activity also grew at the fastest
rate in six months. Euro-zone industrial orders were in line with
expectations in November, registering growth of 2.1% on month and
19.9% on the year.
See today's FXTimes post on those here: Euro-zone Data Showing Strong
Fundamentals, But Euro Starts Week Lower.
*EUR/USD to Retrace?*
The market is assuming that some of the anxiety surrounding the
euro-zone debt crisis has subsided, but we remain very cautious and
with important event risk coming from the US including the Federal
Open Market Committee meeting to decide on interest rates on Wednesday
and the first estimate of fourth-quarter U.S. GDP due Friday, it does
set up the possibility that the current rally reverses and retraces.
**
That sets up the possibility that the US Dollar could flex its muscles
in the second half of the week, especially if the Fed sounds at all
more hawkish of if US GDP data comes in stronger than expected. The
recent stream of US data has been pretty positive and expectations are
for a 3.5% annualized growth rate for the 4th quarter. That would be
up from a 2.6% rate in the 3rd quarter.
While the relief rally for the Euro has been an impressive one, the
underlying problems remain that there is uncertainty and instability
in regards to some banking centers in the Euro-zone periphery. Even if
the immenent fear has subsided, the faultlines are still there. For
now traders have been focusing on the positive.
In the US, the economy has been posting stronger data, but it has
translated to an increase in jobs. Stronger GDP growth, while a
positive needs to go along with better job growth in order to make the
recovery sustainable. We'll get a better idea after this week, but
anticipating these fundamental shifts can help in this week's trading.
Source: ActionForex.Com
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