Column

Price action in the local currency market was pretty placid last week. Rupee’s movements against the US dollar were confined to a narrower range compared to the recent weeks.

While the dollar supply improved on net purchases by the FIIs and dollar sales by exporters, the demand for greenback also remained strong, particularly from the oil companies.

The RBI also continued to actively intervene in the market to prevent rupee appreciation. WPI Inflation remained the key variable of interest, as it climbed to three-and-a-half year high of 7.41%. Speculation about monetary tightening action by the RBI at the end of this month remained rife. The rupee-dollar pair moved in the range of 39.89-40.05 over the week.

In the international currency market, the central banks in Europe influenced much of the price action last week. The pound sterling in particular came under pressure due to the rising speculation of interest rate cuts by Bank of England (BoE). On Thursday, BoE’s third 0.25% cut in its current easing cycle took the UK base rate down to 5%.

Market participants have been anticipating this move after a long run stream of weak economic data. Relief over the rate cut not being bigger even helped the pound rally briefly immediately after the BoE’s announcement. Slowing house prices and a slump in consumer confidence added to the gloom.

Over the week, the pound fell 1.1% against the US dollar and 1.7% against the yen. The euro rose to a new record high against the pound and stood 1.5% higher on the week.

The euro was bolstered by the European Central Bank’s (ECB) decision to leave the Eurozone’s main refinancing rate at 4% for the tenth consecutive month. In addition to its record performance against the pound, the euro also struck a fresh high against the greenback.

ECB president Jean-Claude Trichet, at a press conference after the monetary policy meeting, commented on what he called “excessive volatility” in the currency market prompting speculation about the possibility of market intervention by central banks. He was referring to the sharp appreciation of the euro against the greenback since February this year.

The euro gained another 0.4% against the US dollar last week, but it lost 0.1% against the yen.

On Friday, the greenback’s losses were extended following fears of the Wall Street troubles spilling over to the corporate sector. For the first time in five years, US corporate titan General Electric reported a quarterly drop in profit on the back of writedowns in its financials division. The US dollar fell 0.6% over the week against the yen.

Meanwhile, the US Federal Reserve’s decision on interest rates due at the end of this month has been made more difficult by a large jump in the US import prices. Data released on Friday showed the price of imports from China rose by 4%, reflecting the depreciation of the greenback against the Chinese Renminbi along with higher levels of inflation in China.

In fact last week, the Chinese currency rose beyond the rate of Rmb7 per US dollar for the first time since 1994, taking its gains so far this year to 4%.

This week, a slew of very important US data is due for release. It includes consumer spending, consumer price inflation and data on manufacturing and housing sectors.

Considering that unemployment in the US has risen over last three months while housing prices continue to dip and consumer confidence has hit a 26-year low, the all-important gauge of the strength of the US economy, consumer spending, is likely to point towards further weakness.

At the same time inflation could print higher, considering the spiral in commodity prices in March along with rising import prices in the US. This combination of weak consumer spending and higher inflation would certainly add to the woes of the US dollar, particularly against the euro. Also, a sharp decline in the value of the greenback could push the commodity prices even higher.

While the possibility of the weakness of the US dollar is positive for the rupee, the resultant commodity price inflation would exert a strong downward pressure given that India is a net importer of a number of commodities. Last week, the oil prices crossed the $110 per barrel mark and any further upward move in the crude oil prices would intensify the pressure on rupee from the burgeoning trade deficit.

Along with that, capital inflows could remain elusive this week too, especially from the portfolio front. Risk aversion made a comeback last week on signs that the credit crisis is creating widespread problems in the US economy. However, the Indian equity market and some other Asian markets rallied over the week. Therefore, in case of an extension of the risk aversion, these markets would be prime targets for foreign investors to book profit.

Even the news from the inflation front could prove unsupportive for the rupee. The WPI-based inflation could dip a little, helped by over 0.50% statistical high base effect. Otherwise also it appears that price of some of the essential food items are beginning to ease in response to the government’s measures and prospects of improved supply. Overall, this week could see the rupee under pressure and the rupee-dollar pair could trade in the range of 39.90-40.30.

The author is India economist, ABN Amro Bank. Views expressed herein are personal.
E-mail: gaurav.kapur@in.abnamro.com