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Waiting for political moves
The dollar was unable to strengthen back through resistance at 1.2940 and the US currency weakened to a low of 1.3120. Movement was generally limited ahead of the key events over the forthcoming week and the dollar strengthened back to 1.3040 in New York on Friday. The markets have been focused on exchange rate policy for much of the week and the global policies will remain a very important factor over the next week ahead of the G7 meetings. European and US officials will continue to push for stronger Asian currencies. If there is any movement, the Euro would be unlikely to weaken strongly against the dollar and could actually strengthen as the main focus would be on Asian gains against the US currency. Asian appreciation would also reduce the pressure for Euro gains. There will be a much greater threat to the US currency against European currencies if there are policy rifts between the US and Europe over the US deficits. This risk will be much greater if there is no Asian movement on exchange rates. Unchanged policies would encourage further Euro/dollar range trading even though underlying stresses will continue to build. The headline US GDP report was weaker than expected with a 3.1% increase for the fourth quarter compared with expectations of a 3.5% increase, the slowest growth rate since early 2003. Exports were weak while consumer spending growth also slowed. The other US data over the week was broadly neutral with durable goods orders rising by 0.6% while jobless claims rose slightly. The Federal Reserve will meet next week and the most likely outcome is for a further 0.25% increase in rates. The GDP deflator was in line with expectations at 2.0% for the fourth quarter, although there was an increase in the core personal spending inflation indicator rose to 1.6% from 0.9% the previous quarter. There will be inflation unease within the Fed but the concerns will probably not be convincing enough to prompt the Fed into a more aggressive tightening policy. The policy of steady 0.25% rate increases will offer some dollar support as the yield gap improves, but is unlikely to produce strong gains. US budget concerns will remain an important factor for the markets, especially after the Congressional Budget Office increased its 2004/05 budget deficit forecast. The CBO estimated the deficit would be US$368bn and once the cost of the war in Iraq is added in the total deficit will be significantly over US$400bn. The fact that the US can run such a deficit when the economy is strong will be a serious underlying economic and market concern. There will also be fears that President Bush’s social security reform plans will put upward pressure on the deficit. The budget and current account stresses will remain a key medium-term source of weakness for the dollar. The Euro-zone data was stronger than expected with the German IFO index edging up to 96.4 in January from 96.2 the previous month. The current account remained in surplus and there was a small outflow of portfolio capital which should have a neutral near-term impact. The ECB is likely to remain on hold in the short term. From a medium-term perspective there is likely to be further Euro buying below the 1.30 level against the dollar, especially with global central banks rebalancing their reserves in favour of the Euro. This will limit the potential for dollar gains. Analysis supplied by