As expected, the European Central Bank (ECB) raised their overnight lending rate by a quarter percentage point this morning. The reaction in the foreign exchange market was a bit of a surprise, with the dollar strengthening. This should curb some of the calls for the Federal Reserve to follow the ECB higher. The thinking has been that higher rates in Europe would weaken the dollar and drive oil and other key commodity prices higher. Such thinking has several flaws, the largest of which is the absence of anyone asking why the ECB is raising interest rates at all. The statement that accompanied the ECB’s decision helped temper fears of a dollar collapse. ECB president Jean-Claude Trichet said he has no bias on future interest rate policy and he expects economic growth to slow in coming months. So even if the ECB’s actions differ from the Fed, their view on future economic conditions are about the same. We never thought the Fed would follow the ECB higher. The Federal Reserve is pretty diligent about guarding their independence and we doubt they would back off that on the eve of the Fourth of July.
[I]E. Silvia, Ph.D. Chief Economist, Wachovia[/I]
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Weekly Bank Research Center 07-07-08[/B]
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[B][B][B][B][B] Turkey: Is Growth Holding On and Inflation Near Peak? [/B][/B][/B][/B][/B]
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[I] Stephen Roach, Head Economist, Morgan Stanley [/I]
1Q GDP growth came out higher than expected at 6.6%Y. While the figure suggests at first sight that the deceleration in economic activity might be absent, we believe that the true reflection of declining consumer sentiment, higher interest rates and loan growth as well as the adverse impact of political uncertainty are yet to come. We keep our full-year GDP forecast of 3.5%Y unchanged and consider the stronger-than-expected 1Q GDP print to only lower the downside risks, which were quite considerable, given the sharp rise in energy costs as well as signs of economic weakness in Europe. The 6.6%Y GDP growth in 1Q08 came out higher than both our (4%Y) and consensus (4.9%Y) forecasts on the back of stronger-than-expected private consumption as well as investment expenditures. Part of this strength was due to the presence of a relatively strong base effect, especially on the part of investment expenditures.
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[B] A Summer Theme [/B]
[/B] [/B] [/B] <em> Niels-Henrik Bjørn Sørensen, Senior Analyst, Danske Bank
The past week has seen some important events in the money market that also spilled over to the foreign exchange market. The ECB hiked rates by 25bp - as expected - but did not flag any further tightening of monetary policy. This stance was less hawkish than expected, and it sent yields lower and EUR/USD down almost two big figures. Sweden’s Riksbank also hiked rates by 25bp, but signalled that several additional increases can be expected - this was significantly more hawkish than expected. Despite this significant shock to interest rates, however, EUR/SEK did not manage to go as low as might have been expected, which perhaps illustrates that underlying flows are generally not SEK-supportive at present. While there have been large shocks to the market lately, our general take on G10 FX remains broadly unchanged. We have been warning about the dual shock of the financial crisis and economic slowdown since last autumn. There is still nothing to indicate that the financial crisis is over, and cyclical threats to overextended consumers on both sides of the Atlantic should be enough to temper economic optimism. If the two waves of bank and consumer balance sheet repair collide, which now appears to be happening, the consequences could be ugly. On top of this comes rapidly rising inflation, which has become an increasingly important theme on the financial markets - including the FX market.
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[B] Independent Thinking For The 4th [/B]
[/B] [/B] [/B] [I] E. Silvia, Ph.D. Chief Economist, Wachovia[/I]
As expected, the European Central Bank (ECB) raised their overnight lending rate by a quarter percentage point this morning. The reaction in the foreign exchange market was a bit of a surprise, with the dollar strengthening. This should curb some of the calls for the Federal Reserve to follow the ECB higher. The thinking has been that higher rates in Europe would weaken the dollar and drive oil and other key commodity prices higher. Such thinking has several flaws, the largest of which is the absence of anyone asking why the ECB is raising interest rates at all. The statement that accompanied the ECB’s decision helped temper fears of a dollar collapse. ECB president Jean-Claude Trichet said he has no bias on future interest rate policy and he expects economic growth to slow in coming months. So even if the ECB’s actions differ from the Fed, their view on future economic conditions are about the same. We never thought the Fed would follow the ECB higher. The Federal Reserve is pretty diligent about guarding their independence and we doubt they would back off that on the eve of the Fourth of July.
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[B][B][B][B][B] U.S. Economy Showing More Signs of Weakness [/B][/B][/B][/B][/B]
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[I] Steve Chan, Economist, TD Bank Financial Group [/I]
The biggest telltale sign of all is in the job market. The National Bureau of Economic Research (NBER) – who renders the decision of whether or not the U.S. experiences a recession – tends to put more weight on the employment sector in its assessment. And while hardly falling off a cliff, employment is clearly on a downward trend. Following five months of job cuts, a total of 62,000 jobs were lost in June. Along with yesterday’s report came downward revisions for those last five months, averaging 29,000 jobs per month. Following these recent revisions, June’s figure may also be revised downward. The report also showed that companies are scaling back on hours worked, suggesting that they are trying to cut production costs while avoiding further job losses. June’s drop brings the total number of job cuts to 438,000 since January. Meanwhile, the unemployment rate remained unchanged at 5.5% in June, despite expectations that some of May’s massive half-point increase in the rate would not stick. Despite these unwelcome indicators, the U.S. could pull out some slight growth in the second quarter, helped by the stimulus provided to household spending by government tax rebate cheques. However, as we spell out in our June Quarterly Economic Forecast, this will provide only a short-term artificial boost. By the fourth quarter, we see a real possibility that U.S. activity will shrink outright once this impact lifts.
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[B][B][B][B][B] Bank of England to Hold Base Rate at 5.0% [/B][/B][/B][/B][/B]
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[I] Trevor Williams, Chief Economist at Lloyds TSB Financial Markets [/I]
The Bank of England meets on interest rates this week. A deterioration in forward-looking indicators of activity, worries about the housing market and the reduced availability of credit will have to be balanced with continued increases in inflation. We expect an MPC majority to vote on Thursday in favour of no rate change. The economic backdrop in the UK took a turn for the worse last week after it emerged that credit availability is set to remain tight in Q3, whilst the forward-looking reports of activity in the manufacturing and services industries fell to the lowest level since 2001. The Q2 credit conditions survey published by the BoE showed that both demand and supply of household credit decreased last quarter and are expected to fall further for a fourth successive quarter. The sharp rise in unsecured household lending and a higher projected default rate on credit card loans suggest that the financial position of households could become more fragile. With inflation taking a toll on purchasing power and the labour market showing signs of stress, we appear to be headed for a more challenging consumer environment in the months ahead. The decline in the availability of corporate lending equally demonstrates that the credit crisis is not over, though the expected decline is less than in the three previous months. But higher funding costs could push up defaults - we note that 3-month Libor fell last week to 5.89%, a one-month low. This is especially true for the most leveraged sectors like retail and construction where most of the economic downturn is being felt. However, we would argue that a sustained period of sub-trend economic growth is desirable to help the BoE succeed in bringing inflation back to the 2.0% target in 2010 without having to raise interest rates. With the threat of inflation not over and annual CPI set to hit new peaks over the summer, we believe the BoE is likely to stick to its view that keeping base rate on hold is the best solution right now to bring down inflation over the medium term. The hawkish rhetoric by some MPC members since the June meeting may give the impression that a rate hike is more likely than not, but we are not so sure they can deliver on this and believe that this may be an attempt by the Bank to try and keep a lid on inflation expectations, without having to actually increase the cost of borrowing.
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[B][B][B][B][B] Other Pre-screened Independent Contributors[/B][/B][/B][/B][/B]
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[I] J-Chart [/I]
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