Tuesday, April 5, 2011

China's Rate Rise Unsettles Currencies

China's Rate Rise Unsettles Currencies


LONDON—China's interest-rate increase midway through the European trading session took foreign-exchange markets by surprise, sending the Australian dollar lower and depressing the euro slightly.

The euro traded recently at $1.4165 from $1.4217 late Monday in New York. The dollar was at ¥84.33 from ¥84.03, while the euro was at ¥119.47 from ¥119.52. The U.K. pound recently fetched $1.6234 from $1.6125, while the Australian dollar slipped to $1.0304 from $1.0364.

Agence France-Presse/Getty Images

The Australian dollar slid after China raised interest rates.
.The People's Bank of China raised benchmark lending and deposit rates by 0.25 percentage point Tuesday, when Hong Kong and Chinese markets were closed for a public holiday.

While the timing of the increase was a surprise, the move itself was widely expected as China tries to tackle inflation. "There has been an impact but it is small and I suspect it will be fleeting," said Jane Foley, currency strategist at Rabobank.

The Australian dollar, seen as a key gauge for any slowdown in China, fell on the news but the effect is likely to pass as the Aussie's prospects haven't suffered much, she said. "Markets have become more accustomed to these moves and this hike won't be the last this year," Ms. Foley added.

The Aussie had been weakening after data showed an unexpected trade deficit in Australia and after the country's central bank left interest rates unchanged.

Separately, the pound got a lift from a key survey showing unexpected strength in the services sector which forms the bulk of the U.K economy, taking the currency to its highest level against the dollar since March 24.

The data suggest the U.K's first-quarter performance may prove stronger than expected, in turn strengthening the case for a Bank of England rate increase. The services purchasing-managers' index rose to 57.1 in March from 52.6 in February, research group Markit and the Chartered Institute of Purchasing and Supply said. Economists had expected the services PMI to stay at 52.6.

"Strong March survey data and by implication growing upside risk to [growth] are at the root of pound strength," said Adam Cole, head of foreign-exchange strategy at RBC Capital Markets.

The Bank of England will deliver its interest-rate verdict Thursday but the chances of higher interest rates just yet are very slim.

The euro, meanwhile, has been on the back foot through the European session as investors take a breather after having driven the currency higher on expectations that the European Central Bank will lift interest rates Thursday. Those expectations remain intact but investors are now more concerned on the forecast for rates beyond Apr. 7. The common currency, however, showed little reaction to Moody's one-notch downgrade of Portugal.

The day's European data were mixed with services sector PMIs beating expectations slightly while retail sales were weak. Taken together, they weighed on the euro slightly.

Looking ahead, the U.S. Institute for Supply Management nonmanufacturing index is due at 9 a.m. ET.

"Consensus is for a little-changed headline reading at 59.5, but the index has surprised to the upside in each of the last six months," said Mr. Cole at RBC Capital Markets, suggesting that the dollar may perk up further.

The greenback got a boost late Monday after remarks acknowledging inflation from U.S. Federal Reserve Chairman Ben Bernanke.

Separately, data released by the U.K. Treasury revealed Tuesday that the U.K.'s part in the concerted efforts to tame the yen's strength on March 18 amounted to just $150 million.

The intervention came after the Group of Seven leading industrial nations agreed on a rare joint campaign to tame the yen as the currency shot to record highs following the Japanese earthquake. The dollar hit a record low of ¥76.25 on March 17, and the March 18 intervention succeeded in pushing it back up to ¥82, providing the foundations for further gains through the month.

Many traders had assumed at the time that the amounts involved in the intervention were huge, with the Bank of Japan rumored to have sold around ¥2 trillion, matching the amount it sold in a similar move in September last year.

Geoff Yu, currency strategist at UBS, said the tiny U.K. amount was "symbolic and to show solidarity with the Bank of Japan."

The contribution of the other central banks also would have been for small amounts, Mr. Yu said, adding that the total spend would have been larger if the cash had originated from the Bank of Japan.

Analysts at Nomura said in a note last week that the small amount spent by Japan "does not mean that Japanese authorities' appetite for intervention is any less than it was in September."

They believe Japan would intervene again if the dollar reaches the ¥80 level and there is a significant decline in stock prices.

Nomura analysts noted that Japan's budget for the new fiscal year, which was passed on March 29, raised the ceiling for spending on intervention to ¥36.9 trillion. "With the endorsement of G-7 nations, Japanese authorities have substantial room to prevent yen appreciation if necessary, in our view," they said.

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