The situation within Eastern Europe will be watched closely as any Latvian devaluation would be likely to undermine the Euro, especially as it would reinforce market fears over the Euro-zone banking sector. Rhetoric from Euro-zone officials will also be watched closely and there are likely to be further efforts to curb further appreciation, especially with the economy still in a fragile condition. Markets will tend to look for a firmer Euro, but barriers to gains will remain tough above current levels.
The Euro maintained a generally firm tone during the week with a notable strength against the dollar and Sterling, although it failed to hold the best levels.
There was further verbal intervention by European officials with Portuguese officials, for example, warning that the Euro’s value was not in line with fundamentals.
The German industrial data was broadly in line with market expectations with a further recovery in orders for August and did not have a significant market impact. There was some further unease over the situation in Latvia amid fresh rumours of devaluation and this is likely to have some negative Euro impact.
As expected, the ECB held interest rates at 1.0% following the latest council meeting. In the press conference following the meeting, President Trichet was generally slightly more optimistic on the economy with a suggestion that downside risks were starting to ease, although there was no suggestion of an early move towards tightening.
Trichet continued to express confidence in a strong US dollar policy which was broadly in line with recent comments and there was no aggressive warning over the Euro’s value. As usual, Trichet also refused to comment on the possibility of joint intervention in the currency markets. The measured stance on the Euro will dampen any expectations of near-term action to weaken the currency and also suggests that the bank does not consider that the currency is in the danger zone at current levels.
Yen:
The yen is still proving to be broadly resilient in global markets. There should be some near-term flows into high-yield currencies and capital repatriation will be less of a threat, but the evidence suggest that the yen is not as vulnerable to being used as a funding currency. There is also still the potential for a closing of speculative positions. The authorities will be very reluctant to intervene directly, but will tend to oppose rapid appreciation. Overall, the yen will find it difficult to sustain gains much beyond current levels.
The dollar was unable to gain any significant traction against the yen during the week and weakened to test important support levels close to 88. There was evidence of institutional dollar buying support close to this level and the US currency was able to stage a limited corrective recovery towards 89.20
There was some evidence of capital flows into high-yield currencies, but the Japanese currency was still broadly resilient during the week.
Finance Minister Fujii was reported as saying that the government would be open to intervention on outrageous and reckless exchange rate movements. There was still a high degree of uncertainty over official policy.
There was a small 0.5% increase in core machinery orders for August, but this followed a sharp 9.3% decline the previous month and there was still important underlying weakness in capital spending |