Near-term direction will be determined by the central bank interest rate decisions and policy statements. Increasing doubts over the European outlook should continue to provide important dollar protection with Euro rallies liable to attract selling interest. The US currency will still find it difficult to make much headway given the growth fears.
[B]EUR[/B]
The ECB interest rate decision and press conference will be important on Thursday and the Euro will move very sharply if there is a change in rates, although the bank should hold rates steady. Although a tough inflation stance would support the Euro, the bank may signal a more cautious stance given the growth doubts. The comments from Fed Chairman Bernanke will also be important on Thursday with the US currency vulnerable if he hints over an aggressive series of cut rates. Overall, global growth risks should offer some further protection to the US currency even though the dollar is unlikely to secure strong gains. The dollar should find further support around 1.4750 against the Euro in the short term unless there is a very tough ECB stance with Euro support near 1.4630. Choppy trading conditions are liable to be an important feature on Thursday.
The dollar again found support close to 1.4740 against the Euro on Wednesday and strengthened steadily to highs just beyond 1.4650 in US trading. With no significant US economic data releases, speculation over economic direction was an important influence and Goldman Sachs issued a fresh report stating that they expected a US recession.
Fed Governor Poole expressed major uncertainty over the economic situation, but was still relatively optimistic over 2008 trends while he also stated some caution over the inflation outlook. Comments from Fed Chairman Bernanke will be very important for dollar direction on Thursday with any hints over aggressive action tending to undermine the currency.
Fed funds futures did not move in the dollar’s favour and the rally suggests increased defensive US currency demand as risk aversion and global economic doubts increased. The Euro recovered back to around 1.4690 in early Europe on Thursday before drifting weaker.
International influences will continue to be important for the dollar. There was a further 1.2% drop in German retail sales for November after a 2.3% decline the previous month. Although the industrial orders data was robust on Tuesday, production also recorded a further 0.9% drop for the month. The weak consumer spending data this week will reinforce speculation over a sharp Euro-zone economic slowdown and will increase policy complications for the ECB.
Assuming the ECB holds interest rates unchanged on Thursday, the bank’s statement will be watched very closely for hints on future policy. The ECB will certainly want to maintain a tough approach on inflation, especially as it will want to influence wage negotiations. Nevertheless, the bank is also likely to be increasingly cautious over the growth outlook which would tend to undermine the Euro. Any change in rates on Thursday would trigger a large spike in volatility.
[B]GBP[/B]
Near-term direction will be determined by the Bank of England interest rate decision and Sterling will weaken sharply if interest rates are cut again. The chances of a cut look to be 30-40% with unchanged rates slightly more likely this month. An unchanged policy would trigger a significant relief rally for the UK currency. Underlying confidence in the economy and currency will remain very fragile and rallies will quickly attract selling pressure, especially with expectations of a February cut. Overall, the UK currency could push to 1.9650against the dollar before retreating again. A cut could push Sterling down towards 1.9400 before a sharp potential recovery. The Euro looks to offer very little value at current levels against the UK currency.
Sterling continued to weaken on Wednesday with fresh record lows against the Euro around 0.75 while there was a drop to a 10-month low against the US dollar near 1.9550. The UK currency remained firmly on the defensive in early Europe on Thursday with speculation over an interest rate reduction continuing to undermine the currency. Sterling dipped to 1.9540 against the dollar before correcting higher.
The Bank of England interest rate decision on Thursday is liable to be very close with growth fears offset by unease over inflation trends, especially after the announcement of higher energy prices. The bank is traditionally reluctant to act in January, preferring to wait for more evidence, and the MPC will not want to bow to political suggestions that a cut is possible. Money markets have also fallen sharply over the past month which will alleviate pressure for a further near-term official move.
Sterling will weaken sharply if rates are cut, although there could be a quick recovery given the amount of bad news priced in with volatility likely to be a key feature following the decision. Although unchanged rates would trigger a significant relief rally, underlying sentiment will remain weak with strong speculation of a cut in February.
The headline trade deficit was at GBP7.4bn in November, unchanged from a revised GBP7.4bn the previous month which will not have a significant near-term impact.
[B]JPY[/B]
The yen will remain vulnerable on yield grounds, especially with continuing evidence from the Bank of Japan that interest rates will not be increased in the short term. The yen will, therefore, remain vulnerable on yield grounds and any sustained improvement in risk conditions would increase capital outflows from Japan. There will still be a high degree of caution over global growth conditions which will lessen the potential for aggressive yen selling. A key feature is likely to be a sustained increase in volatility. Overall, the dollar could push to 110.50 if Fed Chairman Bernanke takes an optimistic stance over economic conditions.
The yen was protected by further declines on Wall Street in US trading on Wednesday, although the currency was unable to take full advantage. Dollar support above 109.0 suggests that yen demand has eased, at least to some extent. A late Wall Street rally pushed the dollar to 110.0, but volatile conditions will persist with the US currency below this level on Thursday. The US currency was still showing some greater degree of resilience on Thursday even though stock markets were on the defensive.
Bank of Japan Deputy Governor Muto stated that there were downside risks to the Japanese economy and, although he called for a gradual tightening of monetary policy, the remarks did not suggest that this was a near-term possibility. The yen will remain vulnerable to capital outflows if global risk conditions stabilise.
[B]CHF[/B]
Doubts over the Euro-zone growth outlook will continue to provide some support to the franc within Europe, especially with solid domestic growth data. Levels of risk aversion will remain very important in the short term and the Swiss currency will gain support if global stock markets are subjected to heavy selling pressure. The dollar should, however, find support close to 1.11 against the franc in the short term. Some limited retreat in the Swiss currency is realistic to test 1.12, although heavy selling pressure is unlikely given the overall risk conditions.
The dollar found support close to 1.11 against the Swiss franc on Wednesday, but struggled to hold gains above 1.1150 as the franc moved stronger towards 1.6330 against the Euro.
Degrees of risk aversion remained the dominant influence and the franc secured some further support from fears over growth trends. European retailing stocks came under strong pressure after poor data on sales in Germany which helped underpin the Swiss currency on defensive demand. The franc was holding steady close to 1.1150 against the dollar in early Europe on Thursday.