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Currency Watch: Fed Action Gives Dollar a Boost

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The forex market has reacted in a modestly positive manner to the Fed's decision yesterday to raise the funds rate by 25 basis points and the discount rate by the same amount. Traders around the world believe that the outlook for the U.S. economy is still good and that a soft landing can be achieved.

The Fed's accompanying statement mentioned concern over the threat of inflation in the future and this suggests that further small rate increases can be expected. While these events were fully priced into the market, there has been a modest dollar pop overnight.

The dollar is now trading around 106.90 after closing in New York at 106.80. The euro is weaker around $0.9600. Euro/yen has eased from 103 at New York closing to below 102 in Europe and is now trading at 102.70.

Sterling is again weaker at $1.5645, a new eight-month low. The issue impacting the pound is the trend in sterling/dollar interest-rate differentials, which suggest that U.K. rates will be below U.S. rates in the coming weeks.

The release of the minutes of the

Bank of England Monetary Policy Committee

from earlier this month gave further support to this view as the members were unanimous in leaving rates unchanged (they did however raise the possibility of edging rates higher in the next few months). The euro/sterling cross is marginally softer at 61.35 pence..

As expected, the market's reaction to the U.K. budget presented by chancellor of the Exchequer,

Gordon Brown

, was fairly positive and there is general agreement that the key economic assumptions and policies are reasonable. Adrian Schmit, European economist at

Chase European Economic and Policy Research

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in London feels that, "the budget hasn't done any harm to the Chancellor's image and nobody objects to giving something back."

Schmit sees no reason to expect a major stimulus next year as, "the political climate is against major giveaways."

In his speech, Brown gave strong forecasts of U.K. economic growth with an increase of about 3% expected for the coming year. The budget focused on healthcare, transport and education. The package is estimated to have included net tax cuts of only 1.2 billion pounds rather than the 2 billion to 3 billion pounds generally expected.

Forex traders in London appear to accept the economic outlook described by the Chancellor in which strong economic growth is complemented by inflation below the government's 2.5% target.

The Australian, New Zealand and Canadian dollars remain in recent ranges. Following the U.S. rate increase, the Aussie is a little lower at $0.6065. Similarly the NZ dollar is modestly weaker around $0.4870. After touching highs last week, the dollar is now trading quietly around yesterday's closing levels of C$1.4690.

Despite yesterday's rate rise, the

Dow

and

Nasdaq

closed strongly yesterday with gains of 227 points and 102 points, respectively. Dealers feel that this further supports the dollar in the short term.

The basic structure of forex rates seems unchanged from that outlined in these reports over the past few days and no strong trend is yet in sight. As noted, recent actions in the market by central banks in Japan, Europe and the U.S. have combined to suggest to traders that any sharp volatility will be met by a stabilizing reaction from the authorities. Since market players see no strong reasons to take substantial positions the likelihood is that current indeterminate range trading will continue somewhat longer.