NEWS / Foreign Exchange

Euro hits new all-time high

Highlights

• Worries about extent of credit crisis flare up again
• Earnings of top US banks weigh on dollar
• IMF sees significant downside risks to its growth forecast

Euro hits new all-time high

The US dollar is still under pressure. EUR-USD hit a new all-time high of 1.4319 on Friday morning. The dollar??™s slide against the yen continued too; having climbed to almost 118 at the beginning of the week, USD-JPY temporarily fell back to below 115.

The week had begun quite well for the US currency though. The greenback was boosted by news, which leaked out on Friday, that three major US banks, in cooperation with the US Treasury Department, are proposing to set up a fund to purchase securities and other assets issued by a number of structured investment vehicles which have got into difficulties as a result of the credit crunch. This was taken as a further indication that the credit market crisis can be overcome without substantial macroeconomic consequences. And the fact that the purchasing managers index for the New York region unexpectedly reached a three-year high in October despite the crisis seemed to confirm this.

However, later in the week, the dollar came under pressure as earnings started being published: the market leader Citigroup, for example, reported on Monday that profits were down 57%, and the third quarter results of major Japanese banks showed that Asia is also being affected by the credit market crisis. The Bank of America??™s earnings released later in the week were far lower than analysts had expected.

The dollar did not receive any support from the macroeconomic side either. In addition to extremely weak US housing market data again, the TIC data were disappointing too. In the wake of the credit market crisis, foreign investors sold massive amounts of US securities in August. Thus in the last three months, the average capital inflow from abroad was just $17bn. Even though the flows could to some extent revert to normal again during the coming months, long-term security purchases might still not be enough to finance the US current account deficit. This could also put further pressure on the US currency.

Against this backdrop, investors??™ risk aversion has grown significantly; particularly as the rising oil price and the impending G7 meeting are increasing uncertainty. This week the International Monetary Fund (IMF) published an unexpectedly pessimistic forecast for the global economy. It warned that the financial market turmoil would have a significant impact on growth in the coming year: global GDP growth would probably slow down from 5.4% in 2006 to 4.8% in 2008. In July, the IMF had still been estimating a growth rate of 5.2%.

It should be noted that IMF economists see mainly downside risks to this forecast. The forecast has been made on the assumption that the credit market situation will rapidly revert to normal. If however, distortions persist, the macroeconomic consequences could be more serious. In that case, the IMF expects growth to slow down to less than 3.5% in 2008.

According to the IMF, the risks stem mainly from the US housing market and some European property markets. Furthermore, capital inflows into emerging markets could subside, which would also slow down growth momentum in these countries. In this case, the IMF thinks that the ECB too might have to consider interest rate cuts.

Next week the markets are likely to focus on the G7 statements. In addition, some important indicators are due to be released: we are expecting EMU business and consumer sentiment data to be weaker across the board; in the US, industrial new orders could have recovered temporarily and housing market data will probably remain weak. The markets??™ attention is also likely to turn to the Fed??™s interest rate decision due at the end of the month.

As a few more large banks will be publishing their earnings before the end of the month, we are expecting worries about the extent of the credit market crisis to grow further. This would increase the probability of another Fed rate cut. Therefore the dollar is likely continue on its present course for the time being.