Volatility across most asset classes rose during the week with particularly sharp moves for commodities while global stock markets also weakened significantly. This volatility spread to the currency markets in an environment of increased global uncertainty. The dollar weakened to lows beyond 1.29 against the Euro before correcting back to 1.27 as the US currency corrected from recent sharp losses.
US inflation concerns were a significant focus with a higher than expected core consumer price index increasing fears that inflationary pressure has not been contained. Headline consumer prices rose 0.6% in April, with the second successive core monthly increase of 0.3% pushing the annual rate to 2.3% from 2.1%. Headline producer prices rose 0.9% in April and, although the underlying increase was low at 0.1%, there were signs of rising energy costs being passed on. The price component in the Philadelphia Fed index was also strong and there was an increase in capacity use to levels which could trigger increased inflation. Over the week as whole, there was increased speculation that a further interest rate increase would be required in June.
The US industrial data was firm, but there was a significant 7.4% drop in housing starts to an annual rate of 1.85mn, the lowest figure for 12 months. Following on from weaker consumer confidence data, there were increased concerns that the economy could be slowing at the same time as inflationary pressure rises.
Global exchange rate policies remained an important focus during the week as markets continued to speculate over stronger Asian currencies. US Treasury Secretary Snow called for further Chinese yuan flexibility as a matter of extreme urgency. The latest US capital account data recorded solid inflows of US$69.8bn for March, although there was evidence of a decline in official bond purchases which reinforced speculation over reserve diversification away from the dollar.
Until the middle of this week, there was no significant evidence of European concerns over the Euro’s level, but the position changed over the second half. French Finance Minister Breton stated that everything must be done to stop the Euro strengthening too far against the dollar. The German Economic Ministry warned that the strong Euro could damage the German economy while the IMK economic institute called for intervention to restrain the Euro.
European officials also attempted to move the focus back to Asian currency appreciation by stating that the recent G7 meetings had not called for dollar depreciation against the Euro. The Euro-zone economic data showed some deterioration with the German ZEW index falling to 50.0 in May from 62.7 in April. There were no major complaints over the euro exchange rate from ECB officials with the central bank focussed more on the risk of inflationary pressure.
The UK economic data remained generally firm with a 0.6% increase in retail sales for April to give an annual increase of 3.0%. The Bank of England minutes from the May meeting recorded a three-way split for the first time since 1998. Six members of the committee voted for unchanged interest rates while there was one vote each for an immediate cut and an increase. Sterling briefly strengthened to above 1.90 against the dollar before weakening back to 1.8750 on Friday.
The Bank of Japan left interest rates unchanged at zero at the May meeting and appeared in no hurry to increase rates while the Japanese economy showed further evidence of a steady recovery with annualised GDP growth of 1.9% in the first quarter of 2006. The yen strengthened to highs near 109.0 against the US currency before weakening back towards 112.0 on Friday as short dollar positions were closed.
Commodity-price volatility unsettled the Australian and Canadian dollars during the week with the Australian currency correcting back towards 0.76 against the US dollar while the Canadian dollar weakened to beyond 1.12 from near 1.10.
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