The fall in the Mexican currency wiped out early gains that were fueled by the expectation that the Mexican central bank will maintain its benchmark interest rate at 7.5% tomorrow.

Investors expect the Peso to bounce back due to the widening gap in the difference between the U.S. and Mexican interest rates, with Mexican assets looking increasingly attractive.

Bernanke explained that credit becoming more expensive and less available was causing economic growth to be restrained. He went on to state that the downside risks to growth have increased and the outlook for the economy has worsened in recent months.

It is anticipated that Banco de Mexico will begin to cut rates soon, possibly as early as next month, in an attempt to boost economic growth.

The Fed has lowered the benchmark interest rate to 3% in an attempt to prevent the U.S. economy from falling into a recession. The benchmark interest rate in Mexico is currently 7.5%.

The differences in interest rates have increased the flow of foreign investment, with the Mexican currency rising for the third day in a row. It’s gain so far for this week stands at 0.6%.

Mexico has predicted growth for the country will slow to 2.8%, down from the 3.2% that was estimated in 2007 due to its largest trading partner sitting on the edge of a recession.

Forex investors have already priced in a 50 basis point cut to the value of the USD. Investors expect a 50 basis point cut will see an increase in the value of gold, while a lesser rate cut could see a correction in the price of precious metals.

With economic data today pointing towards a slowing economy with growth in private sector unemployment, there is concern that the 50 basis point cut stock market investors are hoping for may not happen.

While a falling stock market has been proven to consistently boost the value of gold, the precious metal could find itself under pressure as investors and funds are forced to close profitable positions to cover losses elsewhere.

Silver hit a 27 year high yesterday at $16.79 per ounce, with some investors cashing in on profits.

It is expected the Fed will announce its interest rate decision around 7:15 pm GMT.

In other news the Bank of England’s (BoE) inflation report contributed to pressure on the GBP as the Forex market reduced its interest rate expectations. The BoE expects inflation to drop below the desired 2% annual CPI over the next 12 months. The GBP fell briefly as the inflation report was released, but quickly recovered to stabilize about 1.95.

Attention will soon turn to the USD as Forex Investors await Federal Reserve chairman Ben Bernanke’s testimony to Congress, which is expected to cause further weakness to the dollar. The Forex market is expecting Bernanke to suggest that inflation is stabilizing on recent news of retail sales only showing modest gains.

The latest release of minutes from the Federal Open Market Committee meeting (FOMC) revealed that Fed officials are uncertain about the future interest rate direction and are concerned about short term inflation.

Forex Investors reacted to the release of minutes from the FOMC by continuing to reduce their USD holdings, this saw the Euro rise to a high of 1.2650 USD overnight from 1.2590.

The minutes were consistent with the Fed chairman’s Ben Bernanke’s testimony to Congress over the past two days in which he suggested that a pause in rate hikes would be a possibility if economic data continues to point towards slower growth.

Forex Investors holding USD also found little comfort in the recent Philadelphia Federal survey for July which fell to 6.0 index points, well below market expectations of 12.0 index points.

In upcoming events for next couple of weeks, the Federal Beige Book summary of economic conditions will be closely watched as will the next durable goods orders data and the next release of gross domestic product (GDP).

The Riksbank’s goal is to hold inflation to less than 2.0 percent. Inflation has risen over the past year and stood at 1.6 percent in May, but was projected to rise further over the next two years, the bank noted.

“To ensure an inflation rate close to target and contribute to a balanced development of the real economy, monetary policy should become gradually less expansionary,” the bank said Tuesday, motivating its decision.

The higher rate of price increases was partly due to external factors such as rising energy prices, but the bank also cited rising household debt and rapid increases in housing prices in Sweden as causes for concern.

Looking ahead, the bank said economic activity was expected to remain good.

It forecast that gross domestic product (GDP) would rise by 3.7 percent this year, revised upward from a previous growth estimate of 3.5 percent.

Exports and investment would rise faster than previously expected, although consumer spending was now believed to be less buoyant than thought before, it said.

The continuing upswing would be accompanied by rising employment levels, further contributing to inflationary pressures.

“A couple of years ahead, inflation is expected to be in line with the inflation target of two percent,” the Riksbank said.

The bank raised its inflation forecast for 2006 to 1.5 percent from 1.1 percent earlier, and to 2.3 percent in 2007 from 2.1 percent.

These forecasts were based on expectations in Swedish financial markets, reflected in the level of forward contracts, that the repo rate would stand at 2.75 percent at the end of this year and just under 4.00 percent in 2009, the bank said.

But inflationary pressures made more aggressive rate hikes possible, it said.

“It is reasonable to assume that the repo rate will need to be increased further. It is possible that there will be a need for slightly more rate increases over the coming year than recent market expectations have implied,” it said.

Handelsbanken chief economist Peter Kaplan said the central bank’s view on inflation was unexpectedly hawkish.

“We believe this means that the repo rate will be raised another three times this year, and that it should reach 2.75 or 3.00 percent by the end of the year,” he told the TT news agency.

The repo rate was last changed in February, when it was also rose by a quarter point.

SOURCE: AFP

After seven consecutive sessions of gains in the dollar against the Euro, traders trimmed their positions after the Consumer Price Index data cemented the chances of a June Fed rate hike but shed little light on policy moves beyond that.

“The June rate hike was already priced in by the market,” said Marc Chandler, head of global currency strategy with Brown Brothers Harriman in New York.

“Although there’s a slight bias in the market towards another rate hike in August, the May CPI data doesn’t really help us judge what the Fed will do that far out,” he added.

“Short-term players were long dollars going into the data and got squeezed a bit,” said a currency trader with an asset management firm in New York.

The “core” consumer price index, excluding food and energy prices, rose a greater-than-expected 0.3 percent and the annual rate edged up to 2.4 percent, exceeding the upper threshold of what some Fed officials consider acceptable.

Growing expectations that the Fed will raise rates this month and possibly beyond, as well as a diminished appetite for risk, have boosted the U.S. currency this week.

Futures market have fully priced in a quarter percentage point rate hike by the Fed on June 29, the 17th such increase in two years. Traders will now look to the potential for the Fed to raise rates once again at its August meeting.

“The issue now is after June,” Greg Anderson, senior foreign exchange strategist with ABN-AMRO Bank in Chicago, said. “To be fair, the Fed doesn’t know and we don’t know. It will depend on the data,” he said.

Markets are expecting further euro zone rate hikes after the European Central Bank raised rates by 25 basis points to 2.75 percent last week, but investors have scaled back their expectations for the pace of tightening after comments by ECB President Jean-Claude Trichet following the meeting.

Fed officials including Chairman Ben Bernanke have made clear their concerns about inflation risks in the past week, cementing expectations for overnight rates to rise at the Fed’s next policy meeting on June 28-29.

SOURCE: Reuters

JON’S COMMENTS:
Well, I really thought that this news should have given the US Dollar a bit more of a break although I had a bearish view on it and knew this rally should remain fairly short lived. It really turned around quicker than I expected today so let see how it plays up in the coming days/week. My bearish dollar sentiment is surely reinforced here.

“Monetary policy makers agreed that the economy continues to be on the upside in the second quarter, supported by robust exports and a recovery in private consumption and (corporate capital) investment,” central bank governor Lee Seong-Tae said.

“Prices have remained very stable so far, helped by a stronger local currency and falling agricultural prices … but high oil prices, coupled with the economic recovery, will likely to put upward pressure on (inflation),” Lee said.

The central bank has gradually been raising interest rates since October last year as the economy recovers from a two-year slump.
Highlighting the inflation risk, South Korean consumer prices rose at a faster-than-expected pace in May with a year-on-year gain of 2.4 percent after 2.0 percent in April.

“The rate hike poured cold water over already chilled investment sentiment here. Many investors are complaining about the timing,” Hanwha Securities analyst Yoon Ji-Ho said.
“We’re almost nearing the selling climax, although a meaningful rebound seems to be remote,” he added.

Inflation pressure is likely to build as Asia’s fourth largest economy is expected to grow five percent this year, up from four percent in 2005.
Finance and Economy Minister Han Duck-Soo said Thursday the economy was still on an expansion course although pressure from “downside risks,” including high oil prices and a rising won.

South Korea posted its biggest current account deficit since before the 1997 Asian financial crisis in April, hit by high oil prices and seasonal dividend payments overseas.
The deficit more than trippled to 1.53 billion dollars from 426.8 million dollars in March, bringing the total shortfall for the four months to 1.06 billion dollars, Han said.

SOURCE AFP

Bollard said that given the unavoidable nature of the oil price rises, it would be inappropriate to raise interest rates in response.
“We do not expect to tighten policy in response to the high headline inflation in the short term,” Bollard said.
“But equally, we cannot afford to ease policy until we have more certainty that future inflation outcomes will be trading down comfortably below three percent.”

The central bank expects inflation to remain above three percent well into next year.
Reiterating comments made earlier in the year, Bollard said he did not expect to lower interest rates this year despite the rapid slowing of the economy.

Economic growth is expected to slow to 1.6 percent in the year to March 2007, before rising to 2.7 percent the following year.
“Export growth will recover as a result of the lower exchange rate and buoyant demand in world markets,” Bollard said.
“At the same time, household spending will be constrained by a continued weakening in the housing market, high petrol prices and a slowdown in employment growth.”

Many economists had been predicting a cut in the official rate later this year despite repeated indications to the contrary by Bollard. But worsening inflation pressures and a more hawkish tone from Bollard on inflation are making some take a second look at those predictions.
Westpac Bank senior economist Nick Tuffley said the scenario of no rate cut this year was looking increasingly likely.

“The risks to our call for a cut in October are all skewed one way,” Tuffley said.
“However, the Reserve Bank risks overestimating both growth and inflation over the next year, and rate cuts are less distant than it perceives,” he said.

ANZ Bank economists agreed the higher inflation risk made a cut less likely before 2007 but added that any evidence of a sharp weakening of the economy later this year could leave scope for a cut.

“We continue to believe the Reserve Bank will have scope to cut the official rate by the end of the year although this will still require a huge leap of faith on the inflation front,” they said.
ANZ is expecting a relatively strong March quarter gross domestic product number — which is due on June 23 — but economic data will again turn weaker afterwards.

“We expect such a change in domestic data to once again turn the markets attention back to an easing theme sooner rather than later.”

The decision to leave interest rates unchanged was widely expected by financial markets.

SOURCE AFP

The CB noted that the probability of increasing the policy rate in the near future is less now when compared to May, adding that they might lower the rates when the medium term inflation targets seemed attainable. Hence, the CB opted for a once-and-for-all increase in the interest rates to stop speculations of any further rate hikes. They think that this bold move would calm down the markets and prove that the CB could take drastic measures independently when it is seen necessary.

Therefore, we think that the CB not only wanted to take a measure to ensure the attainability of medium-term inflation target, but also to give markets a signal that the relative independency of the CB that we had been enjoying in the last couple of years was still intact.

Nevertheless, we think that even this excessive rate hike would not help the CB to attain the 5% year-end inflation target. In fact, we think that even the CB does not believe in this to happen. What the CB wanted to do is to ensure that the inflation target of 4% set for 2007 could be achieved. Hence, we do not expect an instant turnaround in the inflation readings in the coming months and forecast that the annual inflation by the end of the year would be higher than the upper band.

However, the CB’s determination would help the markets to adjust their medium-to-long term inflation expectations according to the official targets; given that we would not have significant external shocks and the government would show the same determination as the CB.

SOURCE: Yapi Kredi Bank

While high oil prices were the main risk to inflation and therefore a major reason for the rate hike, we believe that the recently sliding rand – which will likely come under further pressure on the back of the ECB rate hike and the expected rise in US interest rates – lent support to the decision.

SOURCE: Danske Bank

The possibility that the Fed will raise rates for the 17th straight time to 5.25 percent sparked a round of dollar short covering, helping the U.S. currency recover from a sell-off on a soft employment report late last week.

But gains were limited as some investors worried that Bernanke’s comments did not necessarily guarantee that a rate rise is in the bag this month.

“The market is more or less split between whether the Fed will raise or not, so it’s hard to take on risk either way at this point,” said Fumihiko Kawano, forex manager at Nomura Securities.
Fed funds futures indicate a roughly 70 percent chance of a rate hike at the Fed’s two-day policy meeting that starts on June 28, up from less than 50 percent on Friday.

Traders said any recovery was likely limited with the renewed focus on a weaker dollar helping rein in the massive U.S. trade deficit and playing a role in correcting global imbalances.
“Bernanke’s comments may have triggered some short covering … but a rise in the dollar/yen to 113 yen is going to be pretty tricky,” said Nobuaki Kubo, forex planning manager at Resona Bank.

So far this year the dollar has tumbled 8 percent against the euro and 5 percent versus the yen, with the slide accelerating after the Group of Seven industrial powers called in April for China and other trade surplus countries to allow more currency strength.

RATES AND DEFICITS
Even if the Fed raises rates later this month, it would likely be the last before the central bank takes a break from the two-year run of credit tightening, just as other major central banks look set to bump up rates.

Dealers said that the dollar could face more downward pressure if the European Central Bank hikes rates at its policy meeting on Thursday, with speculation still simmering of a potential half-percentage point increase.

Most analysts expect the ECB to lift rates by 25 basis points to 2.75 percent and to signal more credit tightening is likely in store.

Global imbalances are also expected to be a focus later in the week with the release of U.S. trade figures on Friday, just as the Group of Eight finance ministers meet in St. Petersburg.
Japanese Finance Minister Sadakazu Tanigaki said the impact of high energy prices on the global economy would be a topic at the G8 meeting.

SOURCE: Reuters

JON’S COMMENT
How much further will the US extend its gain this week and could this be a good time to short the Dollar before the European Central Bank officially announce its rates hike? Even with a rate hike for the US Dollar later this month, with a likely pause afterward and some weak data, I believe the US Dollar will go back to it’s recent lows in the coming months.

Forex traders will admittedly be watching economic indicators closely for insight into the Fed’s likely course of action. This includes data on the housing market, for the Fed could conceivably continue to raise rates as long as the housing market remains overly buoyant.

Goldseek reports:

The economy grew 4.8% in the first quarter of this year. Inflation is at the upper end of the Fed’s comfort level. If we see another two months of that type of environment, it is likely they will raise rates yet again…

In this vein, Ben Bernanke’s hint that the Fed might end its cycle earlier than expected probably hastened the dollar’s decline.In this vein, Ben Bernanke’s hint that the Fed might end its cycle earlier than expected probably hastened the dollar’s decline.