There will be further concerns over the Euro-zone growth outlook in the short-term, especially if banking-sector fears intensify. The ECB will remain concerned over inflation and will still retain a tough policy, at least in public, as containing inflation expectations will be a key policy objective. There is, however, still no real scope for interest rates to be increased. There is likely to be increased political and industrial pressure for Euro gains to be capped while calls for rate cuts will also increase if growth fears intensify.
The Euro has retained a firm tone against high-yield currencies over the past seven days. The currency lost some ground against the Japanese yen and Swiss franc as global stock markets came under pressure.
Euro-zone industrial orders fell 1.6% in September which cut the annual growth rate to a nine-month low of 2.0% while French spending growth also weakened sharply. The Euro-zone November PMI index for manufacturing rose to 52.6 from 51.5 previously, but the services index fell significantly to 53.7 from 55.8 and overall concerns over growth trends increased.
There were expressions of concern over the Euro's level with Euro-Group head Juncker stating that it was no longer possible to take a benign approach to the Euro gains while German Chancellor Merkel also expressed concern over the Euro.
ECB President Trichet also stated that he was against rapid and brutal currency moves. These comments indicate that concern over the Euro's strength is increasing, although Trichet held back from actually describing the recent currency moves as brutal. This is an important distinction and still signals reservations over intervening.
The September Euro-zone current account surplus fell to EUR0.6bn from a revised EUR4.5bn previously, although trade is still not a major issue at this stage. There was also no evidence of major capital outflows which will offer Euro reassurance.
Denmark announced that it would hold another referendum on whether to introduce the Euro, but this did not have a significant impact.
Yen:
The short-term yen moves will continue to be dominated by levels of global risk aversion and the outlook for carry trades. The yen will be sold at times on yield grounds, although the most likely outcome is that there will be a further net reduction in carry trades as risk aversion remains high. There will also be some risk of carry-trade capitulation which would trigger sharp gains. There is evidence of increased official tolerance for yen gains, but there will still be opposition to disorderly markets which will slow yen gains.
The Japanese currency strengthened against all major currencies over the week. Against the dollar, the yen broke through the August 2007 highs and pushed to 24-month highs near 107.50 before a retreat to 108.0.
The yen gained important strength from an unwinding of carry trades as risk aversion remained high due to persistent credit-related fears. The Japanese capital account data was strong in the latest week with increasing evidence of capital repatriation.
Comments from Finance officials over the yen gains were generally limited with no strong warnings against the moves which suggests some tolerance of a stronger yen.
The government did, however, express concern over the domestic growth trends with concerns over the implications of weaker US growth.