U.S. Dollar Bounces Back, Risk Sentiment To Dictate FX Price Action

U.S. Dollar Bounces Back, Risk Sentiment To Dictate FX Price Action

Talking Points

Japanese Yen: Mixed Amongst Majors

British Pound: BoE Sees Inflation Holding Above Target

Euro: Holds Narrow Range

U.S. Dollar: Benefits From Risk Aversion

Increased fears surrounding the European debt crisis pushed the euro to a low of 1.3684 on Thursday, and the single-currency may continue to depreciate throughout the North American trade as investors scale back their appetite for risk. According to the Novi List newspaper in Croatia, the central bank Governor, Zeljko Rohatinski, was told by European Central Bank President Jean-Claude Trichet that the rise in the budget deficit paired with increasing labor costs could push the country "into a catastrophe" as the nation prepares to join the euro-area in 2012. As the governments operating under the fixed-exchange rate system tighten fiscal policy in order to balance their public finances, there could be increased pressures on the ECB to support the real economy over the medium-term, and the central bank may see scope to maintain the expansion in monetary policy throughout the beginning of 2011 as price pressures remain subdued. The ECB reiterated that current interest rates remain "appropriate" in its monthly report, and went onto say that the non-standard measures are "temporary in nature" as the central bank raised its economic forecast for the region.

The central bank sees GDP expanding 1.6% versus an initial forecast for a 1.1% rise in the growth rate, while the economy is expected to grow 1.5% in 2011 amid an earlier projection for a 1.4% expansion. Despite the upward revision for GDP, the ECB sees inflation averaging 1.5% throughout 2011, and lowered its 2012price growth forecast to 1.6% from 1.7%. As the central bank maintains a dovish outlook, we may see the ECB talk down speculation for a rate hike in the beginning of the following year, but recent comments from Governing Council board member Jose Manuel Gonzalez-Paramo suggests that the ECB will look to normalize monetary policy over the coming months as the economic recovery in Europe gathers pace. Mr. Paramo said that it is "perfectly possible" that the central bank will raise borrowing costs before withdrawing its extraordinary measures during an interview with Expansion newspaper, and sees scope for a rate hike in the "medium term" if inflationary risks materialize.

The British Pound fell back from a high of 1.6178 during the European trade following the rise in risk aversion, but we are likely to see the sterling continue to outperform against its currency counterparts as investors scale back speculation for further easing. Meanwhile, Bank of England Governor Mervyn King urged global leaders to address global imbalances at the G20 Summit in South Korea, and warned that "the next 12 months will be an even more difficult and dangerous period" as the economic outlook remains clouded with uncertainties. As the BoE maintains its wait-and-see approach, the central bank is likely to keep the benchmark interest rate at 0.50% and retain its asset purchase target at GBP 200B over the coming months, and the MPC may see scope to start normalizing monetary policy in the first-half of the following year as the economic recovery in the U.K. gradually gathers pace.

The greenback bounced back against most of its major counterparts on Thursday following a rise in safe-haven flows, and risk trends are likely to dictate price action throughout the day as the economic docket remains bare for the North American session. As the U.S. observes Veterans Day, there could be muted price action across the major currencies as market liquidity thins, but we expect the rise in risk aversion to carry throughout the day as equity futures foreshadow a lower open for the U.S. market. However, as the G20 Summit is scheduled to carry into Friday, comments from global policy makers could spark volatility in the fixed exchange market as rumors of a currency war resurface.

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