[B]Traders holding breath for ECB President Trichet Speech, UK & EURO zone Interest decisions.[/B]
Yesterday, the Fed decided to leave rates unchanged and now market attention will be focused on the rate decisions made by the ECB and BOE. The dollar was little changed after yesterday’s comments, so the ECB may be the guiding light for any EUR/USD strengthening or a break of the important level 1.3540. The USD held steady against the European currencies and the JPY after the Fed statement. Some market participants will likely view the Fed’s acknowledgment of the recent slowdown in economic activity as a “baby step” toward an eventual interest rate cut. But the main message for forex traders seems to be that the Fed didn’t seem to be fazed by the slow first quarter growth. The Fed continues to believe that the economy is going to grow faster, and that the drag from housing will decrease (that is why they continue to be focused on inflation). Many economists expect the central bank to hold back until later this year, when Fed officials could cut rates to combat rising unemployment.
The Fed’s last rate change occurred last summer, when it hiked the funds rate for a 17th straight time. Since then, rates have been held in check and the dollar has been relatively weak.
The EUR continues to stabilize just above the ascending trendline stemming from late March, around the 1.3520-30 region. The European Central Bank, which is the monetary authority for the EURO, is scheduled to meet later today and is widely expected to keep interest rates on hold at 3.75%. The rates decision will be declared at 12:45 GMT. However, the real action would begin when the ECB head, Mr. Jean Trichet starts his speech at 13:30 GMT We anticipate the use of the word �vigilance� in describing the ECB’s stance against risks to inflationary pressure which could signal a 25bps rate hike to 4.00% in the next meeting, which is scheduled for 06-June in Frankfurt. The markets would also be looking at Trichet’s stance on inflation, given that the M3 for the EUR region last came in at 10.9%, on 30-April. The last declared EUR CPI was at 1.8%, which is just below the top end of ECB’s �Comfort Zone� of 2.0%. It would be worthwhile to note that Trichet used the words �"VERY CLOSELY MONITOR" on his stance on inflation in the ECB’s last meet.
EUR 10-Year Bunds yields are already discounting a June hike and they are trading near their highest levels since July 2004. The 6-Month EUR Libor is at 4.16%, which is also its highest level since Aug-2001.
These are the reasons that the EUR has been in a relentless uptrend against the USD, JPY and the CHF so far in 2007 and has seen gains of 3.05%, 3.82% and 2.56% against these currencies respectively.
Now, with the FED on hold and BOJ unlikely to raise rates for sometime now, the EUR could maintain a longer term uptrend against USD and JPY. However, the SNB, the Central bank of Switzerland is likely to raise rates in its next meet, so the EUR performance against the CHF may be tepid. Today an Interest rate statement also expected from the UK and will take place at 12:45 . The Bank of England will certainly be concerned over inflation at this month’s meeting. Indeed, the bank faces one of the toughest periods since it was given independence 10 years ago. The consumer inflation rate increased to 3.1% in April from 2.8% previously, more than 1.0% above the target level, while headline wage inflation rose sharply to 4.6%.
The bank will need to control inflation expectations as failure to control inflation now would cause serious difficulties in the medium term. In his recent lecture, bank Governor King stated "�there is no more important challenge than keeping inflation and inflation expectations anchored on the target.�
Overall, there is a strong probability that the Bank of England will increase interest rates during this meeting, especially as growth indicators have remained firm. There has been speculation over a 0.5% increase in rates at the meeting and a 0.5% increase would reinforce the case that the bank is very serious about bringing inflation down. An increase of this size would, however, risk destabilizing the economy and the bank will have to consider the fact that interest rate increases take time to take effect. The GBP on the other hand, will likely storm upwards given an 0.5% increase.
A 0.25% rate increase looks to be the more likely outcome, possibly on a split vote. Assuming rates are increased, the tone of the bank’s statement will be important and hints that rates are unlikely to rise again would tend to weaken Sterling.
Overall, the UK currency is unlikely to gain strongly on a 0.25% increase, especially as there would be some disappointment that rates were not increased by 0.5% and Sterling could actually weaken.
The UK currency will weaken sharply if there is a no change in rates. Sterling will jump stronger if there is a 0.5% rate increase, but gains could reverse rapidly on fears over weaker growth. We maintain our near-term bullish outlook on the single currency if the pair can manage to remain above this key support level, which should result in EURUSD eventually pushing higher toward the 1.37-level. However, if EURUSD breaches this level we would then anticipate a setback to our view and an initial test lower to 1.3365.
Bank of Japan Governor Toshihiko Fukui reiterated on Thursday that the central bank will guide monetary policy gradually based on the economy and price levels, while carefully monitoring risk factors.
Japanese money supply update: (JP April M2 Money Supply YoY: 1.1% v 1.1% expected; Broad Liquidity: 2.6% v 2.5% expected) The money supply data showed that depositors are shifting funds from high-liquidity money such as deposit money to time deposits, with the rise in interest rates. This would please BoJ governor Fukui, who warned during today’s session that low rates may foster inefficient asset allocation. ‘The BOJ will strive to manage monetary policy appropriately and contribute to sustained growth under stable prices,’ Fukui told an upper house financial committee. The BOJ raised the key interest rate by a quarter percentage point to a decade-high 0.5% in February and has kept monetary policy on hold since then thus causing downward pressure on the JPY.
In the last couple of days a tight channel 1.3514 -1.3563 can be observed on the hourlies and a breach of one of the barriers will determine the immediate trend.
On the daily chart a channel with a negative divergence between 1.9863 - 2.0135 may imply an upcoming bullish trend. In other words, the pattern, called “Broadening Bottom”, may be the determining factor in the general trend of the pair. RSI and Slow Stochastic are neutral however expected to gather some new forces while will motivate the upcoming bullish trend.
On the daily chart a classic head & shoulders pattern is forming and this pattern implies an upcoming bearish trend which take this pair to consolidate at 118.67. This pattern is also supported in the 4 H chart but still need to be complete. In this case going short is possibly the preferable strategy .
The RSI and Slow Stochastic on the 4H chart are both at over-bought territory and showing a negative divergence which means that the bearish trend is not out of steam yet. This trend is expected to test the support level which is located at 1.2155, in case of a breakout the next significant barrier is located at 1.2100 however unlikely to be breached today.
[B]The Wild Card
Forex traders are waiting for the upcoming bearish trend when a symmetrical triangle is establishing on the 4H chart. On the 2H chart the 5 Elliott Waves pattern is forming and implies a bearish move of the A and C waves that eventually may take this pair to 162.52. Preferable strategy is to trade in the direction of the trend.