Foreign Currency Report –21st November 2007

USD

The dollar fell to a record low against the euro on Tuesday as speculation swept the currencies markets that the Federal Reserve was set to deliver an emergency cut in US interest rates. Traders said the talk was that that the Fed would cut interest rates when it released its new growth forecasts and the minutes from its October meeting last night. The dollar fell 1 per cent to an all-time low against the euro, dropped 0.8 per cent against the pound and lost 0.8 per cent against the Swiss Franc. With Thanksgiving on Thursday most of the action is expected to take place early in the week. Major focus of the week will be on FOMC minutes and Fed's new projections on inflation, growth and unemployment. Currencies in New Zealand, the U.K., South Africa and Norway gained as the prospect of lower rates in the U.S. enticed investors away from dollar-denominated assets. The dollar also fell on speculation a group of six Arab nations will end their fixed exchange rates to the U.S. currency.

EUR

ECB policy makers, led by President Jean-Claude Trichet, have said this month they're concerned that rising prices may unleash an inflation spiral and unhinge expectations of what he calls ‘price stability.' Mersch dismissed concerns that the euro's appreciation to a record and two years of ECB interest-rate increases threatened the 13-nation region's economic growth. He said stagflation was a term he wouldn't ‘endorse.' European Central Bank governing council member Yves Mersch said a ‘second-round' effect from the current acceleration in inflation would probably prompt an increase in interest rates. Mersch, head of Luxembourg's central bank, said ECB policy makers are following wage talks with the ‘greatest vigilance' after a surge in oil and food costs sent euro-region inflation to 2.6 percent, the highest in two years.

GBP

The UK inflation data is below the 2% target level with both the headline and core rate at 1.8%, but there are still doubts over the underlying inflation trends. Similarly, there are major uncertainties surrounding short-term growth prospects. The PMI (field marketing agency) surveys for October indicated a significant slowdown in the economy with the manufacturing and industrial surveys both weakening while industrial production also fell for September. Credit conditions have tightened and market interest rates remain at elevated levels.

There is the probability of a significant slowdown in the economy as consumer spending slows. There is the potential for a much more serious downturn, especially in view of the underlying housing-sector vulnerability and high debt levels. Overall, the Bank of England is likely to sanction a cut in interest rates late in 2007, although it could decide to wait until early 2008. Any evidence of a sharp housing slowdown would be very damaging for the UK currency and the overall risks are on the downside for the currency.

In the short term, there will still be important protection from underlying dollar weakness, but the UK currency looks to be at unsustainable levels.