Euro Falls on Disappointing German GDP

• JPY Merchandise Trade Balance better than expected
• EUR German GDP not as rosy as it looks
• GBP Big surge in business investment
• USD only jobless claims and help wanted on tap

The EURUSD dropped through the 1.3100 level for the first time this week as the internals of the German GDP data painted a far bleaker picture than the rosy headline number. Just as expected, the final measure of German GDP registered an impressive increase of 3.7%, however after traders looked at the individual components of the release their mood soured and they quickly sold the euro as a result The overwhelming majority of growth came from the export sector which expanded at 6.0% rate versus 4.5% expected. On the other hand, Government Spending actually compressed by -0.1% versus 0.2% and more troubling still Domestic demand declined by -1.3% versus a 0.5% projected increase. The highly unbalanced nature of the release suggested that the ECB may have to pause after the expected 25bp hike in March. With the recent strength of the EURUSD coming from the assumption that ECB will continue to ratchet rates higher throughout 2007, this sudden reassessment of the situation took the wind our of the latest rally as market players curbed their bullishness.
Meanwhile, one day after the BOJ rate hike, the yen continued to play victim to carry trade flows, with the market paying more attention to fact that the Japan’s central bankers promised to follow a gradual rather than a sustained tightening schedule. Nevertheless, as we’ve noted several times this week, the rate hike matters in the long run, especially in light of the fact that the expected rate increases from the high-yield currencies like the Aussie, pound and the euro may not necessarily materialize. The carry trade is always as much about the relative direction of the interest rate spread as it is about its absolute value. Therefore, while yen still appears to be weak it may not remain so much longer if the market comes to the conclusion that the global tightening cycle is over.