Weekly Bank Research Center 6-05-06
ECB meeting in the shadow of rising inflation risks
Niels-Henrik Bjørn Sørensen, Senior Analyst, Danske Bank
The most important event of the coming week is the meeting of the ECB.s Governing Council, which is generally expected to raise interest rates by 25bp. However, there is some speculation in the market that the ECB could opt instead for a 50bp hike. Strong data and an underlying hawkishness on the part of several council members have contributed to this risk. On top of this, Governor Trichet said at the last press conference that the ECB would be strongly vigilant, rather than just vigilant. So it can be argued that the ECB has opened the door to a more aggressive monetary policy than before. We reckon that the ECB will limit itself to a 25bp hike, and do not expect Trichet to signal a further in-crease in July at the ensuing press conference. A certain risk of this is also being priced into the market. Only if the data remain very strong and inflation risks pick up will the ECB more seriously consider stepping up the pace of tightening. This could, for instance, happen at the September meeting on August 30, but here too we expect the ECB to stick to 25bp.
Economic Transitions: Slower Growth, Higher Interest Rates and Inflation
John E. Silvia, Ph.D. Chief Economist, Wachovia
This year has seen a change in the fundamentals of interest rates, inflation and energy prices. As these factors have changed, the pace of consumer spending and housing developments has changed. Our outlook at the start of the year was for real economic growth to slow and for core inflation to inch up. Indeed inflation has risen above the Feds presumed two percent target. Moreover, interest rates have risen and profit growth has slowed. Overall, the pattern of these changes is consistent with the typical mid-phase of the economic cycle. However the risks for decision-makers have increased noticeably as expectations have become increasingly volatile as we enter neutral territory.
USD - the top of the iceberg
Lone Olesen Analyst, Jyskebank
FX dealers are a rum bunch. Reckless and quick to take decisions are some of the epithets usually given to FX dealers by other participants in the financial markets - and yet: lately we have witnessed hesitation and dither among FX dealers on the subject of the dollar. The great Doomsday scenario attached to the obvious need of the US for a weaker dollar has intermittently been uppermost among focus points. This time is just another repetition, isn't it? Market participants are obviously divided over whether we are about to see the much-feared dollar weakening that will go down into history like the dollar depreciation of 1985-1988 after G7's Plaza Accord in 1985. This uncertainty/division is the logical sequel to the repeated crying wolf which has echoed round the markets with varied intensity for years. So much the worse, since violent swings stem from great uncertainty which adds force to the spiral of fear and greed.
Opposing forces keep dollar in balance
Jörg Isselmann Economist, Bhf Bank
Although there was no lack of new data this week, EUR-USD did not manage to break out of the trading range of around 1.27 to 1.29 in which it has been since the middle of May. Towards the end of the week, the single currency was hovering around 1.28. Against the yen, however, the dollar was able to gain further ground: at the end of the week, USD-JPY was trading at just under 113, significantly above the eight-month low of 109.76 in the middle of May. The forex markets hardly reacted at all to the surprising nomination of Henry Paulson as Treasury secretary John Snows successor. By nominating the Chairman and CEO of the investment bank Goldman Sachs, President Bush has chosen a widely respected Wall Street figure for the Cabinet. However, many financial market players are wondering whether even such a highly esteemed man as Mr Paulson will be able to achieve much in the mere two and a half years which the Bush administration has left, particularly as it is in danger of losing its majority in both houses in the congressional elections this November. At any rate, Mr Paulson is not expected to talk the greenback down. In that respect, his nomination is certainly likely to support the dollar.
Will interest rates rise in June?
Trevor Williams, Chief Economist at Lloyds TSB Financial Markets
In June, a number of key central bank meetings are due to take place. Global interest rates are on a rising trend. This is being driven by evidence that faster economic growth and higher energy prices are leading to
a rise in actual and expected inflation. But although the world economy is experiencing a period of synchronized economic growth (global growth is in its third year of plus 4% expansion), there are still significant divergences in rates of growth between different countries. These in turn lead to differences in inflation rates and so in interest rates between economies. In June, central banks in this analysis may be concerned by the rise in inflation, as shown in chart a. Moreover, falling or low rates of unemployment, shown in chart b, suggest that economic growth is solid. In this briefing, we look at where interest rates may be headed in four major economic zones based on a simple monetary policy approach.
The Weekly Bottom Line
Steve Chan, Economist
It was a busy week on the Canadian economic calendar, with two heavyweights of note on tap. First up was the balance of payments report on Tuesday. Although, the current account surplus narrowed in the first quarter of 2006, from $13.0 billion to $10.6 billion, it still represented the third-highest level on record. It also comes on the heels of the oil-induced all time high set in the final quarter of 2005. Next up was the quarterly report on real Canadian gross domestic product (GDP), which revealed that the Canadian economy advanced at a strong annualized pace of 3.8% in the first quarter almost a full percentage point above both consensus expectations and Canadas potential growth rate. Gains in consumer spending and residential investment were more robust than originally thought at 4.6% and 14.2%, respectively driving a spectacular 5.0% jump in overall domestic spending. Still, it was the trade component that was most surprising. Despite the further surge in the Canadian dollar in early 2006, exports managed to hold their ground relatively well in the first quarter falling by only 0.9%. Meanwhile, business investment continued to grow at a solid rate (+9.2%), while governments increased outlays by 2.3%.
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