Firm rhetoric on inflation could provide some Euro support, but the ECB is likely to maintain a steady policy in the short-term which will limit support. There will be persistent fears over structural weaknesses, especially as it will be extremely difficult to adopt a convincing strategy to cut budget deficits in countries like Greece. In this environment, underlying Euro sentiment is likely to remain fragile and there is still some risk of heavy selling pressure on fears that there will be more severe tensions within the area.
The Euro held its ground against the dollar, but was unable to make much headway as underlying sentiment remained fragile and was subjected to renewed selling late in the week, undermined in part by rumours that German Chancellor Merkel would resign.
The Greek government announced that it would launch a fiscal stability plan on Wednesday, designed to cut the budget deficit to 3% of GDP within three years. There were still very important doubts whether a credible plan could be put together. The Euro was also unsettled by comments from German Chancellor Merkel who stated that the Greek budget situation risked damaging the Euro.
China’s increase in reserve requirements, allied with weaker than expected earnings from US company Alcoa unsettled the Euro to some extent as risk appetite deteriorated, although the impact was measured as the dollar found it difficult to gain.
As expected, the ECB held interest rates at 1.0%. In the statement following the meeting, President Trichet again commented that interest rates were at appropriate levels and that the risks to growth were broadly balanced.
Trichet stated that it was absurd to speculate that any country could be forced to leave the Euro area, although he was still reluctant to make substantive comments on the situation surrounding Greece’s government debt position.
Yen:
Underlying confidence in the Japanese economy will remain weak in the short-term, especially with fears over the government-debt situation. Exchange rate policies will remain important and there will be continuing pressure for yen gains to be resisted. There will also be speculation that the government will now be more willing to push the currency weaker. A lack of confidence in the other major economies and currencies should still offer some degree of yen protection.
The yen tended to trade erratically over the week as markets struggled to find a clear direction. Some caution over global economic prospects helped protect the Japanese currency from heavy selling pressure and the dollar was unable to push back above the 92.50 level against the yen.
In comments on Tuesday an official of China’s sovereign wealth fund stated that the dollar had hit bottom and had little room to decline while the yen was likely to weaken. These comments triggered a spike higher in the dollar/yen rate.
The latest Japanese machinery orders data was sharply weaker than expected with a substantial decline of 11.3% for November which pushed the series to a record lows since the data started in 1987 and undermined confidence.
The data increased fears over the economy and maintain pressure for the Bank of Japan to provide additional support to the economy. There was also additional pressure for the authorities to weaken the currency.
Finance Minister Kan stated that currency rates should be set by markets unless there are rapid moves.
China continued to have an important influence on the Japanese currency during the day and an increase in reserve requirements, allied with expectations of further tightening triggered a downward move in the dollar against the yen. |