Currencies

Friday May 9, 09:19 AM
Forex - Euro rebounds as euro zone interest rate outlook remains unclear

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LONDON (Thomson Financial) - The euro firmed against the dollar as markets continued to digest yesterday's European Central Bank interest rate decision and the lack of any signal that borrowing costs in the 15-nation currency zone will fall

anytime soon.

The ECB's decision to leave rates unchanged at 4.00 percent yesterday was widely expected, but many markets watchers were anticipating the central bank would acknowledge the risks of an economic slowdown had accelerated.

However ECB president Jean-Claude Trichet stuck to his guns, emphasising that preventing a prolonged period of high inflation remained the bank's primary concern.

'There was the slightest of chances Trichet would acknowledge the softening of economic data - in the event he offered few crumbs here and in discussing inflation he even removed references to it being temporary,' said Gavin Friend, currency strategist at Commerzbank (Xetra: 803200 - news) .

The euro has weakened against the dollar in recent weeks as investors betted that while the U.S. Federal Reserve is on the verge of ending a rate-cutting series the ECB is about to start one.

But Trichet's hawkish tone yesterday dashed any hopes that this was set to come anytime soon and unsettled markets' interest rate outlooks.

'Trichet's apparent intransigence has ruffled a market that had become short euro in a relatively brief period of time, and the shake-out could see the euro move higher against the dollar,' said Daragh Maher, currency strategist at Calyon.

However Maher added that he believes euro zone economic data will continue to take a turn for the worse in the coming months and will force the ECB to change its tone.

'The fixation may be on the fact that inflation is above target, but we suspect that the data on activity will continue to deteriorate, and ultimately turn intransigence into capitulation with a rate cut in September,' he said.

With little major European data out this morning, markets main focus today will be on the U.S. trade figures out this afternoon.

The trade deficit is exported to have narrowed during March as the weak dollar supported exports.

Elsewhere the pound was lower, undoing most of the gains it posted yesterday following the Bank of England's decision to leave interest rates unchanged at 5.00 percent.

While the decision was largely expected, there was some speculation the BoE would have opted to cut following a run of soft UK data in the run-up to the decision. This meant the pound rallied yesterday afternoon but it has fallen back this morning as markets saw the unchanged decision as merely a pause before a another cut in June.

'There's a longer term assumption that rates will come down in London during the year with perhaps as much as 100 basis points to be seen in the months ahead, although high fuel and oil prices do mean that the threat of inflation breaking higher cannot be ignored either,' said CMC Markets analyst James Hughes.

Finally the yen was firmer as risk aversion crept back in to financial markets following another record high for oil prices and poor set of results from U.S. insurance giant AIG.

Steve Pearson, currency strategist at HBOS (LSE: HBOS.L - news) , said equity markets are showing signs that they could be entering another period of pro-longed weakness, which will provide ongoing support for the safe-haven Japanese currency.

'The major equity indices are struggling to push much beyond a 50 percent retracement of the initial November (Frankfurt: A0S9N7 - news) to March sell-off and are now entering what looks on the basis of previous equity bear market experience the most likely timeframe for a second leg down,' he said.

'Reflecting this the yen has started to gain traction, with some weakness evident in relatively high yielding and emerging market currencies,' he added.

London 0849 GMT Tokyo 0415 GMT

U.S. dollar

yen 103.07 down from 103.52

Swiss franc 1.0422 down from 1.0488

Euro

U.S. dollar 1.5460 up from 1.5408

yen 159.44 down from 159.52

Swiss franc 1.6152 down from 1.6155

pound 0.7912 up from 0.7877

Pound

U.S. dollar 1.9532 down from 1.9556

yen 201.44 down from 202.45