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Forex Opinion: Again on knife edge

by Anthony Byett,

Sunday 16th November 2008

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Markets are notoriously sensitive to small events. Right now appears to be a case in point.

Financial markets have generally tracked sideways in most recent weeks, albeit in a whippy fashion and over a wide range.

The major exceptions are oil, the GBP and the Indonesian rupiah, and short-term interest rates which are each still in freefall. Today there are a number of shares and currencies moving towards levels that suggest another more general bout of freefall; any minor event could set the panic in motion.

However there has been an enormous amount of government action (even if the G-20 weekend response was lame) and narrower bank credit spreads point to better functioning global money markets. What’s more, coordinated currency intervention is likely should the JPY in particular appreciate further (and the likes of the EUR, AUD and NZD depreciate). Thus a continuation of the broad sideways pattern for exchange rates in general appears the more likely outcome in the next few weeks.

Closer to home, another pivotal event will be the RBNZ monetary policy decision to be announced 4-December. The market is expecting a 1% reduction in the cash rate to 5.5%. In the meantime the RBA is likely to reduce the Australian cash rate by a further 0.5% to 4.75%. More importantly (for currencies) the market is now pricing short-term rates to reach 3.5% in Australia but only 5.2% in New Zealand (see interest rate futures). Such a gap is anomalous with relative growth and inflation prospects and is likely to narrow, dragging the NZD/AUD closer to 80c; should the RBNZ surprise with a more hawkish stance then it will be 90c that becomes the magnet.

Forex Opinion is written by consultant economist, Anthony Byett. Anthony's knowledge stems from 16 years as economist for ASB, which included 5 years as Chief Economist.

Anthony has a passion for fx, and applies that enthusiasm towards informing exporters, importers and investors of the driving forces in foreign exchange markets. You can visit Anthony's website here.

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