Euro strengthens on expectations of new rise in interest rates

The euro has continued to strengthen as expectations grow of an imminent interest rate rise when the European Central Bank meets tomorrow. If rates are not raised this week it is expected that they will be increased in two weeks. Meanwhile expectations for higher US rates have diminished, which is also benefiting the euro. The euro has broken through the key level of $0.9510 to close at $0.9570.

Many economists expect the ECB to increase interest rates at this week's meeting from the current level of 3.75 per cent to 4 per cent. However some forecasters feel they will hold off increasing rates until their next meeting in a fortnight. Dr Dan McLaughlin, chief economist at ABN Amro, does not expect an increase this week and pointed out that in recent months the ECB has preferred to hint at a rate rise at the press conference following one meeting, before actually implementing one at the next meeting, after which no press conference is held. Meanwhile, expectations regarding US rates are also changing. According to Mr Jim Power, chief economist at Bank of Ireland, the markets now expect US rates to peak at around 7 per cent within a year from 6.5 per cent at the moment. And contrary to expectations only a few weeks ago, the Fed is no longer expected to raise rates at its next meeting on June 22nd.

Mr Power added that it is now increasingly likely that the euro has passed its point of maximum weakness. "It can go up to $0.98 over the coming weeks and a test of parity is not out of the question," he said.

"The growth convergence between Europe and the US, which everyone was talking about at the beginning of the year, might actually be happening," said Mr Alex Blinkhorn, chief trader at Bank of Tokyo-Mitsubishi in Dusseldorf. "The general direction for the euro is up." The currency is still down some 18 per cent against the dollar, and for now, "95 cents is a fairly attractive level to sell euros," Mr Blinkhorn warned. Data released yesterday further reduced rate expectations in the US. Figures showed that worker productivity grew at the fastest pace in seven years during the first quarter, compared to the same period last year. Stronger productivity strengthens the case for not raising rates, because it keeps inflation in check.

Non-farm productivity, a measure of output per hour worked, was 3.7 per cent higher than in the same three months of last year. That matched the fourth-quarter pace and was the largest since a 4.2 per cent gain in the final quarter of 1992. Compared to last year's fourth quarter, productivity increased at a 2.4 per cent annual rate in the first three months of the year, the same as previously estimated.

At the same time European figures showed that confidence is soaring. The outlook for euro zone's economy held at a 10-year high for the third straight month in May, as industry booked more orders and falling unemployment boosted consumer confidence.

The European Commission's index of consumer and business confidence remained at 104, the highest since May 1990. A separate report showed a drop in euro-11 unemployment to 9.2 per cent in April from a revised 9.3 per cent in March.

The jobless rate in the euro region fell to its lowest level since July 1992, led by Luxembourg, the Netherlands, Austria and Portugal. Spain's jobless rate remained highest, falling to 14.1 per cent from 14.4 per cent. The jobless roll in Germany remained at 8.4 per cent, while in France it fell to 10 per cent from 10.2 per cent. Unemployment in the EU as a whole slipped to 8.5 per cent from a revised 8.6 per cent in April, compared with 3.9 per cent in the US and 4.8 per cent in Japan.