Euro Headed Higher, US Dollar Back to the Drawing Board

July 1, 2008

We are back to the drawing board with the US dollar. Strong consumer spending and the lowest unemployment rate in 14 years could force the ECB to backtrack on their words and actually prepare the market up for more than one rate hike in the third quarter. The June consumer price index is expected to be at 4% double the ECB’s 2% inflation forecast.

Up until now the ECB has openly hinted that a rate hike in July will one-off, but with inflation pressures continuing to increase and growth resilient, 2 rate hikes from the ECB this year is more than realistic.

Other than raising rates by 25bp and moving to a neutral stance, which the market has already discounted, there are 2 other options that Trichet may be considering. One would be to gain the upper hand on inflation by hiking rates by 50bp instead of 25. The second would be to raise rates by 25bp and leave the door open for another rate hike this year. Closing the door completely could be mistake especially as oil prices heads towards $150 a barrel.

As for the US dollar, we are back to the drawing board. The greenback is declining against the Japanese Yen, Euro and British pound. Fears of trouble in banking sector including a profit warning from UBS and talk of a bargain basement sale of Lehman Brothers has stocks set to open lower. The greater the decline in stocks, the lower the chance of a rate hike by the Federal Reserve in the third quarter and the bigger the reason sell the US dollar ahead of the ECB meeting.

Posted in ECB, US Dollar, ecb rate hike, euro, euro rate hike