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The RBI last week did what market participants had largely expected it to do.
Firing its first salvo against inflation, the central bank announced a hike in the banks’ cash reserve ratio (CRR) by 0.50% in two stages to 8% on Thursday.

With headline WPI based inflation ruling at a three-year high, some form of monetary tightening was to be expected. The timing of the CRR hike also leaves the door open for policy rate hikes on April 29th when the RBI announces its monetary policy for the current fiscal year.

The impact of the tightening of the monetary levers is broadly positive for the rupee in the medium term. In the week ahead also, the rupee could receive limited boost from the CRR hike. But the RBI is standing in the way of the rupee strengthening beyond 39.90 at the moment. Its intervention has also been more effective as pace of capital inflows is not strong.

Portfolio investors remain marginal buyers of Indian equity, thus closing down one of the key routes of capital inflows.

In the meantime, downward pressures through the merchandise trade front continue to build-up.

International crude oil prices climbed to $116.5 per barrel, rising 5.8% last week. Food prices too are scaling new highs, with rice crossing $1,000 per tonne. And prices of another of India’s key imports — fertiliser — are now sky rocketing.

Overall, with exports likely to be sluggish, the chances of the trade deficit ballooning further and exerting pressure on the rupee are only increasing. The Indian unit has managed to withstand these pressures till now, helped by the US dollar’s widespread decline.

Otherwise, in a holiday-shortened last week, the rupee traded in a very narrow range against the greenback. The rupee-dollar pair moved in a band of 39.91 - 39.987. This week the pair could trade in the range of 39.80 - 40.20. Improvement in the equity market conditions could provide some support to the rupee.

Trading in the major currency pairs in the overseas market was particularly volatile last week. The US dollar gained on positive surprises from the first quarter corporate results, particularly in the technology sector. A strong performance by equities restored risk appetite and the Japanese yen fell sharply as a result.

The pound sterling outperformed the other major currencies, on hopes that the Bank of England (BoE) will soon announce a rescue plan for mortgage lenders, which will help improve liquidity and revive the British housing market.

The euro notched record highs against the greenback and the pound during
the week, but lost ground on Friday.

Economic data in the US showed further deterioration in activity levels and although core inflation rose less than expected, inflationary pressures remained strong.

On the other hand, higher inflation numbers reinforced the view that the European Central Bank (ECB) will not ease policy rates in the near future. That sent the euro to record highs against the dollar and the pound.

The single currency finished the week marginally higher against the greenback and the yen, but lost value against the pound.

The pound rallied sharply over the second half of the week. Besides growing speculation about the BoE bailout plan for mortgage lenders, news that one of the biggest UK-based bank will announce capital raising plans, also helped the pound.

It rose 1.4% against the dollar and gained 4.1% against the yen over the week. The pound also advanced against the euro, rising 1.3%, after hitting a record low against the single currency on Thursday.

With equity markets conditions improving, yen-funded carry trades were back in favour. Equity markets in the US and Europe had a good week. Moreover, the popular index of equity market volatility, VIX, slipped below 20 for the first time since late December. This was seen as a positive development for equities. These conditions pushed the yen down by 2.7% each against the euro and the dollar.

This week too, the dollar can hold its ground and even gain in value. With no major data releases due this week, there would be no major negatives for the greenback.

Only the housing and durable goods data is due for release. Mortgage applications have rebounded and this suggests that sales of existing or new homes could have actually increased during the month of March.

Given the lack of any major economic data to threaten the latest rebound in the greenback, the rally could continue. In the medium term however, the prospects of the US dollar still look bad.

In the week ahead, market participants will get to see a host of important data on the euro-zone. That data will shed more light on the health of the region’s economy. Service and manufacturing sector PMI reports are due for release along with the German IFO report on business sentiment.

Analyst sentiment as reflected by the ZEW survey tumbled and it is possible that the business sentiment will follow suit. Any weakness in these data points would put pressure on the euro.

The author is senior economist, ABN Amro Bank. Views expressed are personal. gaurav.kapur@in.abnamro.com