The prospects for US interest rates remained the dominant influence over the past week with a series of key US economic data and the debut congressional testimony as Fed Chairman for Ben Bernanke.
The US data was mixed over the week, but had a firm tone, supported to a considerable extent by weather considerations. Activity did not drop as much as usual over the month and the seasonal adjustment factors pushed up the reported headline data. There was, for example, a jump in retail sales for January with a 2.3% monthly increase while housing starts rose to an annualised rate of 2.28mn in the latest month, the faster pace of new construction since 1973. Conversely, the weather conditions helped push industrial output down as utility output dropped over the month while there was a further advance in manufacturing output as capacity use increased slightly.
The manufacturing surveys for New York and Philadelphia had a firm tone for February, but stayed near recent average values and failed to have a major impact.
Producer prices rose 0.3% in January with a 0.4% underlying increase as transport prices rose.
In his testimony to congress, Bernanke’s comments were very similar to those made after the latest Fed meeting at the end of January with the Fed Chairman anxious to avoid any remarks that could destabilise markets. Bernanke continued to state that the Fed may have to increase interest rates again, especially with the economy operating at near-full capacity, but he also repeated that near-term moves will be dependent on forthcoming data. Bernanke emphasised that there was the risk of tightening too far or not enough and rate expectations could still prove to be volatile over the next few weeks.
The level of capital flows into the US slowed sharply in December to US$56.6bn from US$91.6bn the previous month as private purchases of bonds fell sharply. There was also an increase in US purchases of overseas assets, a trend that has been seen consistently over the past few months as US investors have pushed funds overseas. The markets were still concentrating on yield considerations and market expectations that US rates would increase to 5.0% resulted in a dollar challenge on the 1.1850 resistance level against the Euro.
Japanese monetary policy was also a persistent background focus as Japan recorded strong annualised GDP growth of 5.5% for the fourth quarter of 2005. Although the GDP deflator also increased for the quarter, the evidence suggested that the Bank of Japan was on high alert over an ending of the quantative monetary policy. The yen was volatile over the week with gains to 116.85 against the dollar reversed as the yen weakened to 118.75 on Friday.
The UK data was erratic over the week with stronger than expected readings for unemployment and earnings, together with indications of firm house prices, offset by a sharp drop in retail sales. Seasonal adjustment problems are also important for January data in the UK and the February/March data will provide more reliable evidence on growth trends.
The headline consumer inflation rate edged down to 1.9%, below the Bank of England’s 2.0% target.
The Bank of England’s inflation report indicated that the bank would prefer to keep interest rates on hold due to the uncertainties over growth and inflation trends in the economy. Sterling weakened to lows near 1.73 against the dollar and trading choppily against the Euro.
Oil prices fell sharply over the week with crude prices dipping significantly below the US$60 p/b level while there was also a drop in gold prices. The retreat in commodity prices resulted in selling pressure on commodity currencies as speculative positions were cut. The Australian dollar, for example, weakened towards 0.7350 against the US dollar with the Canadian dollar retreating to 1.16 at one point before a recovery. The New Zealand dollar fell sharply to a 16-month low below the 0.6650 level against the US currency.
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