Column

A six-week rally for most of the world’s equity markets ground to a halt last week as fresh worries about the financial sector overshadowed further tentative signs of economic stabilisation in many regions. However, the deterioration in risk appetite indicated by the modest drop in share prices did little to boost the safety appeal of the US dollar, which lost ground against the euro and the Japanese yen.

It was the pound which was worst performing major currency last week. It came under fire after the poor state of UK’s public finances was confirmed in the 2009 budget. On Wednesday in the budget, the UK government shocked markets with the announcement that it was to issue a record £220 billion of government securities in the current financial year. It added that by 2014, public debt would reach 79% of GDP.

Moreover, the UK government’s economic growth projections were met with some scepticism from all quarters. The government estimates that the British economy would contract by 3.5% this year then stabilise and grow by 1.25% in 2010 and by 3.5% in 2011.

The caution around these forecasts appeared to be borne out by Friday’s data showing a 1.9% slump in GDP growth in the first quarter of 2009, meaning that on an annual basis GDP contracted by 4.1%. This far exceeded the 1.5% quarterly decline expected by the market and was the sharpest quarterly drop in 20 years. The pound fell 2.5% over the week against the euro and by 2.8% against the yen. The pound’s losses were capped, however, as equity markets continued to rally and sentiment, though becoming more fragile, continued to favour risk.

Against the US dollar, however, the pound’s weekly fall was only 0.8%, as the greenback remained prone to periodical selling depending on investors’ appetite for risk. Equity markets were a little more volatile, but many advanced over the week, encouraging some risk taking. The greenback’s weekly fall against the euro was 1.6%, and versus the yen it was 2% lower.

Among other major currencies, the Canadian dollar was down more than 2% by Wednesday after the central bank cut its main rate to 0.25%. That left market participants with the notion the Canadian central bank would soon move towards quantitative easing of monetary policy. The currency’s recovery was swift, however, when on Thursday the bank announced a “prudent” approach, saying that it would not immediately seek to implement unconventional policy until it had seen if the measures taken already had an impact. Against its US counterpart, the Canadian dollar recovered to stand relatively unchanged on the week.

The Swedish central bank, Riksbank, cut its policy rate by 50 basis points to 0.5%, which came as a surprise to the many expecting a 0.75% cut. The Krona rose by 4% against the US dollar and by 2.5% to versus the euro.

Some emerging market currencies found strength towards the end of the week. On Friday alone, the Turkish lira rose 1.9% and the Hungarian forint added 2.4% against the greenback.

In the local inter-bank market, rupee had a rather volatile week, as its movements against the US dollar were largely dictated by the equity market gyrations. The Indian unit slid for the first three days of the week, as the stock market gave up some of its recent gains. Over this period the greenback also strengthened globally.

Over the last two days the rupee rallied along with the stock market and recovered all its losses over the week to finish slightly stronger over the week. The rupee-dollar pair traded in the range of 49.74- 50.59. The stock market turnaround and the resultant rupee rebound was to some extent helped by a 0.25% rate cut by the RBI taking some market participants by surprise.

This week, we have a flurry of important data and events from the US economy and that will be the centre of attention in the market. Foremost among them is the release of the first quarter US GDP numbers. This data is critical in the back drop of claims from various US government officials, including president Obama himself, of initial signs of stabilisation and a decelerating pace of recession. Their assertions will be confirmed or denied by the GDP data. As the world’s largest economy, should the data confirm a slower pace of annual contraction (as economic forecasters predict) it would be the first tangible sign that conditions are indeed improving. And that, in turn, could reinforce the risk sentiment in the market, drive up the equities market further and undermine the US dollar.

The other key event this week is the US Federal Reserve’s rate decision. There is growing consensus that the US central bank will further shrink its target interest rate range, but such a move would mean little. However, the market would look towards the Fed’s outlook on the economy. Any sings of optimism from the Fed would also boost the appetite for risk in the market.

For the price action in the rupee-dollar pair, the equity market movements would remain crucial. Any improvement in the global investor sentiment would help the local equity market and thus the rupee. However, rupee’s gains could be tempered if the commodities, particularly crude oil and gold also see a rise in prices. Month-end demand for dollars from importers would also keep the pressure on the rupee. Overall, the rupee-dollar pair could trade in the range of 49.75-50.50 this week. The pair could continue to witness heightened volatility.