Foreign Currency Report 28 September 06

USD
Over the past few days we have seen significant strength in the Dollar due to a number of contributing factors. The Dow Jones stock index has moved closer to hitting a record closing high, with investors boosted by easing concerns over US inflation. It ended up 24 points to 11,694 on Wednesday, closing in on its all-time high of 11,750 reached in January 2000. The Dow is continuing to benefit from falling oil prices and signs that US interest rates may have peaked. Economists are hopeful that consumer spending will remain resilient in the face of a cooling economy. Consumer confidence rose unexpectedly in September, helped by falling petrol prices and more confidence in the job sector. Sales of new US homes unexpectedly recovered in August, rising 4.1% from July, official figures show. The annual rate of new home sales totalled 1.050 million last month, compared to 1.009 million in July, the Commerce Department reported. The August rise followed a 7.5% fall in sales in July, but was still down 17.4% from the same month in 2005. The average price of a new home was $237,000 (£126,000), down from $240,100 a year earlier. "The story is that the housing market is still on a downward trend," said economist Patrick Fearon of AG Edwards & Sons. The latest housing figures came after separate official data indicated that new orders for US-made durable goods fell unexpectedly in August. It was the second monthly decline in a row, and the first time since April-May 2004 that orders for durable goods items meant to last three years or longer, fell in consecutive months. Despite US consumer sentiment continuing to hold up a survey showed that it rose strongly in September the ongoing downturn in the housing market is likely to concern investors.

Euro
Meanwhile in the Eurozone we have seen significant strength, with one analyst stating that the the Euro has become the currency of choice. The euro strengthened on speculation the European Central Bank will keep raising interest rates this year as the fastest economic growth since 2000 stokes loan demand and threatens to fuel inflation. The European currency has gained more than 7 percent against the dollar and yen as traders increase bets the ECB will lift rates twice more this year. The bank needs to rein in money supply because borrowing costs are too low, council member Axel Weber said in a Sept. 26 speech in Baden Baden that was published yesterday on the Bundesbank's Web site. ``The euro is well supported after Weber's comments,'' said Masafumi Yamamoto, a strategist at Nikko Citigroup Ltd. and a former Bank of Japan currency trader. ``An October rate hike is already a done deal. Investors are looking for criteria for a December rate hike as well. ''The euro rose to $1.2719 against the dollar in London from $1.2701 late yesterday in New York. It climbed to 149.61 yen from 149.22. The dollar traded at 117.63 yen from 117.49 yesterday. The European currency may rise to $1.29 against the dollar by year-end, Yamamoto said. The Frankfurt-based central bank has lifted its key rate four times to 3 percent in the past year. It next meets on rates Oct. 5. By contrast, the Federal Reserve left its rate at 5.25 percent for a second month. The Bank of Japan increased its benchmark from zero percent for the first time in almost six years in July.

GBP
Sterling has recently been affected by a series of mixed economic data. UK economic growth was unexpectedly revised down to 0.7% in the three months to June, official figures show. An overestimation of the impact of the World Cup on the UK's gambling industry partly led to the downwards revision in gross domestic product. The Office for National Statistics had previously estimated growth of 0.8% for the second quarter. However, the year-on-year rate of GDP growth remained at 2.6%. The ONS said the downwards revision in second-quarter growth was also a result of new health service figures, which showed that hospital admissions had been lower than expected. The downwards revision came as a surprise to economists, many of whom had expected the second-quarter figure to remain unchanged. The ONS also revised down the GDP deflator, which is a key measure of inflation, to an annual rate of 2.2% from 3.4%. "The marginal downward revision to quarter-on-quarter growth does not materially change the outlook for interest rates," said Howard Archer, chief UK and European economist at Global Insight. "However, we believe that growth is likely to lose some momentum over the coming months as consumers continue to face significant headwinds and exports are limited by a slowdown in global growth." House prices were "unseasonably strong" in September, shrugging off August's rate rise, the Nationwide has said. The building society's latest housing survey found that prices rose by 1.3% during the month, lifting the annual rate of growth to 8.2%. This was the fastest yearly growth rate since February 2005, and the average UK property now costs £169,413. The three-monthly trend showed prices rose 2.2% in the three months to September, on the previous quarter. Demand in the housing market remained "firm" said Fionnuala Earley, Nationwide's group economist. "Just like the weather, the housing market was unseasonably warm in September as August's interest rate hike did nothing to cool the rate of house price inflation," she said "Buyer interest remains robust as estate agents continue to report strong enquiries. 'However, fewer sellers willing to put their properties on the market is adding to already squeezed supply which increases price pressure." Sterling fell to a one-week low against the dollar, whilst short sterling futures trimmed losses on Wednesday after Bank of England policymaker David Blanchflower said inflationary expectations have levelled off. Blanchflower also said that the labour market looks set to weaken further and the economy may have more capacity than data has indicated. His comments cast a shadow of doubt over wide-spread expectations that the BoE will hike interest rates to 5 percent in November.