Rupee to be range-bound with a weakening bias

US dollar bearishness could be tested this week by inflation data

The euro reiterated its position as the strongest global currency last week. It rose against the US dollar on the back of dovish statements by the Federal Reserve chairman Ben Bernanke and weak US economic data.

The pound sterling also gained ground as the market scaled back its UK rate-cut expectations. The Japanese yen, which has seen a sharp recovery in recent times following a loss of risk appetite among global investors, tripped across the board as risk appetite recovered.

A glimmer of hope in the form of stronger-than-expected US retail sales and Japanese GDP growth helped improve investor sentiment.

The US dollar suffered last week after comments from Bernanke cemented expectations for further cuts in the Fed rate. In his testimony to the US Congress on Thursday, Bernanke reiterated the downside risks to economic growth and said the Fed stood ready to take action in response.

Bernanke said a significant worsening in financial conditions or in credit availability “would certainly be a warning bell that we need to take further action”.

This was seen as an endorsement for more rate cuts, including a 0.50% cut in the March policy meeting.

Bernanke also added that he expected a stronger pace of US growth to start later this year, as the positive effects of the recent monetary and fiscal stimuli are felt. The greenback fell 1.1% against the euro over the week, extending its fall after the Fed’s manufacturing index posted its largest ever fall in February.

The US dollar, however, rose by 0.4% against the yen over the week as rising risk appetite weighed on the low-yielding Japanese currency. On Wednesday came news of a surprise rise in US retail sales in January. It was followed on Thursday by a report showing expectation-beating Japanese GDP growth in the fourth quarter.

Both the news items helped ease some concerns about the deteriorating health of the world’s two largest economies and improved investor sentiment, undermining the yen.

Over the week, the yen fell 1.54% against the euro, 1.1% against the pound and 1.8% against the Australian dollar.

Meanwhile, the pound found support after the Bank of England’s quarterly inflation report tempered expectations of aggressive interest rates cuts. The BoE said its projections for UK consumer price inflation were higher than projections in its November assessment, especially in the near term, because of sharp rises in food, energy and import prices.

These projections seemed to suggest that the BoE could cut rates by only 0.50% in the coming months, and not by more, meaning the rate would come down to 4.75%. The pound rose 0.8% against the greenback over the week, but eased 0.3% against the euro.

Among other major currencies, the Australian dollar put in an impressive performance, rising 1.4% against the greenback. That happened as the country’s unemployment rate fell to its lowest level in 33 years, stoking expectations that the Reserve Bank of Australia would raise interest rates by 0.25% to 7.25% at its policy meeting next month.
In the local market, the rupee remained under pressure last week. Dollar shortage in the banking system persisted throughout the week. That, matched with a lack of fresh dollar supply, pushed banks to enter buy-sell swaps between the spot and the forwards market.

As a result, the rupee slipped sharply over the first three days of the week. Stock market declines during these days also added pressure on the rupee.

The rupee’s losses were contained by dollar sales by exporters, who took advantage of the rupee-dollar pair slipping beyond 39.80 on Wednesday. The equity market rally over Thursday and Friday also helped improve the sentiment. Over the week, the rupee-dollar pair traded in a range of 39.60 - 39.89 and the rupee closed marginally weaker against the US dollar.

In the rupee-dollar forwards market, premia rose across tenors over the week, as dollar shortage was relieved. But by Wednesday, forward dollars up to 4 month period were selling at a discount to spot on account a cash dollar shortage.

Also, the latest data from the RBI shows that it had outstanding forward dollar purchases of $8.3 billion by the end of December. The central bank has been intervening through the forwards market since October now.

This week, the international price action would largely remain dollar bearish. The minutes of the Fed’s January monetary policy meeting are due for release. Considering that the Fed cut rates by 1.25% last month, the minutes are unlikely to change the market perception about future rate cuts.

The consumer price inflation data is also due and a stronger-than-expected reading will temper some of the dollar bearishness.

In the local market, the rupee would continue to trade in narrow range versus the greenback with some weakening bias. Crude oil prices, having climbed back to $95 barrel, will weigh on the rupee, especially since the pace of capital inflows has eased. Last week’s support from the equity market could be tested.

On the other hand, if the risk appetite among global investors improves any further, we could see a pick-up in the otherwise tepid portfolio inflows. The rupee-dollar pair can trade in the range of 39.50 - 39.80 this week.  

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