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After a few weeks of narrow range-bound movements, the rupee resumed its northward journey last week. This was made possible by a surge in capital inflows, particularly portfolio flows.

The Indian unit rallied as foreign institutional investors (FIIs) brought in $2.13 billion to purchase Indian equity and debt over the week. A major part of these inflows were towards their purchase of the DLF shares, which got listed last week. Exporters also offloaded dollars noting steady decline in the value of the greenback versus the rupee.

High crude oil prices and RBI intervention offered some tough resistance to rupee’s ascent. And, after trading in a range of 40.385 - 40.675 versus the US dollar, the rupee finished the week stronger by 0.7%. More significantly, the rupee-dollar rate closed below the level of 40.50. This was a level which the RBI had defended quiet firmly in June.

The dynamics behind the price action rupee-dollar pair are likely to put the rupee under some pressure this week. Crude oil prices at 11-month high of $76 per barrel will pull the rupee down and the RBI is also likely to maintain a steady presence in the market.

Comfortable rupee liquidity situation within the banking system could also keep the Indian unit from gaining too much ground. With overnight call money rates under pressure to ease in the face of surplus funds and their generally lower levels compared to the overnight dollar rates, it would incentivise banks to hold long dollar positions.

The support to the rupee from capital inflows could also be rather tepid. After a flush of capital inflows last week, this week might not see large inflows. And the magnitude of portfolio inflows would certainly not match the quantum of inflows seen last week.

In fact the portfolio inflows received in the first week of July took total net purchases of Indian assets by the FIIs to $4.4 billion since April. This implies that inflows last week almost equalled inflows in the whole of first quarter of the fiscal year.

Under such conditions and in the presence of some strong downward pressures, the rupee could slip against the greenback this week. However, the bullish market sentiment towards the Indian unit backed by equities market rising to new levels and soft US dollar overseas, would provide support to the rupee. Market participants, particularly exporters would take advantage of any decline in the value of the rupee to sell dollars.

Thus, while the rupee could come under some downward pressure during this week, it is unlikely to loose much ground against the greenback. The rupee-dollar pair is likely to trade in the 40.45 - 40.90 band.

In the overseas market, the US dollar could continue to underperform the European majors, the euro and the pound sterling. Last week the greenback lost value to both these currencies despite some strong data releases. Prospects of higher rates in the Eurozone and a 25 bps rate hike by the Bank of England underpinned the outperformance of the European majors against the US dollar.

Strong data, however did help the greenback recover some of its losses during the week. The dollar bounced back from close to a record low against the euro and its weakest level in more than 25 years against the pound. Lack of yield support relative to other main currencies was the primary factor damaging the greenback early in the week, with stress in the US credit market also weighing on sentiment.

But the US dollar climbed as concerns over the credit market receded and firm data, including robust surveys of the US manufacturing and services sectors on Monday and Thursday and Friday’s above-forecast US jobs report, helped US bond yields move sharply higher.

Lack of positive surprises from the Bank of England and European Central Bank after their policy meetings on Thursday also cleared the way for the US dollar to rally.
This week some important US data releases are due. These include retail sales, an all important barometer of the strength of consumer spending and trade balance. The trade balance is expected to improve while retail sales are predicted to be particularly weak.

In fact, expectations are so low that a small upside surprise could still be dollar positive. The greenback could also find support from the speech of the Chairman of the Federal Reserve, Ben Bernanke on inflation. Risks are clearly skewed for rise in inflation and a stronger reinforcement of this view by Bernanke would help the greenback.

Otherwise with expectations of the Fed holding rates unchanged this year while both central banks in Europe likely to raise them, firmly entrenched in the market, the US dollar would remain under selling pressure.

The Bank of Japan will hold its monetary policy meeting this week and its quiet improbable that it would provide support in form of a rate hike to the beleaguered Japanese Yen, just yet. The Japanese currency continued to trail against the high yielding currencies, but finished flat against the greenback last week.

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