Wednesday 28th May 2008

ECB rate cut = “wishful thinking”?

Prominent fears of stagflation (inflation and stagnation) appeared to contribute to the Sterling weakness against the US Dollar yesterday. Not helping the GBP was the release of a Hometrack survey showing a fall in house prices in England and Wales for the eighth month running and a 40% year-on-year drop in April’s mortgage approvals.

Across the pond the US Dollar experienced a lift following a report showing stronger than expected US new home sales data and a retreat in oil prices. This phase did not last long however as the EUR took the lead once again. The US Dollar fell compared to the Yen and CHF following the FBI saying that a video will be posted soon urging Islamic militants to attack the West via biological, chemical and nuclear weapons.

Oil is the key at the moment for the greenback as they seem to move inversely in recent times. If we see a fall in oil prices inflation worries will quieten down and make investors believe the worst is over.

Recent data released in Europe gave reason for concern over the health and stability of its economy. The EUR suffered following a slump in French business confidence to a 2.5 year low and an unforeseen decrease in Germany’s consumer morale for the month of June. Investors are looking for action from the ECB and a change from its neutral perspective to dovish. However ECB members themselves declare this as “wishful thinking” and a different approach to its monetary policy is yet to be seen. Looking at the global economy market participants feel that the US has seen the worst of it and that Europe is only at the start of its economic slowdown. The FED has adopted a very dovish tone since fears of a recession first appeared and tried to counter-act with rate cuts totalling 3.25 percentage points since September however with inflation now beginning to be the main focus the market will be looking for the Fed’s next move to be an increase in rates.

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