Vigilant Trichet today

EURUSD climbs further, and Trichet will likely use the key phrase "strong vigilance" in today's mone

(05.05.2011) EURUSD climbs further, and Trichet will likely use the key phrase "strong vigilance" in today's monetary meeting. Disappointing numbers from the US service sector was a further weight on the dollar yesterday. The NOK weakened on disappointing retail sales, but we maintain our view that Norges Bank will resume hiking in May.

By Kjersti Haugland, Senior Economist at DNB Markets

EURUSD continues to rise, driven by the diverging prospects of US and euro zone monetary policy. Euro zone retail sales disappointed the market yesterday, by declining 1.0% m/m in March, while a 0.1% rise was expected. The fall exceeds the preceding two months of rise. Nevertheless: There is still a firm belief in the markets that the inflation hawk Trichet will use the phrase "strong vigilance" in today's press release from the monetary policy meeting, indicating that the next hike will come at the next meeting in June.

The dollar weakening was enforced by a steep and unexpected fall in the US service sector ISM in April, from 57.3 to 52.8. It is a small comfort that the equivalent index for the manufacturing sector remains above 60, when the latter stands for only one tenth of US value added. ADP employment was also on the weak side of market's expectations, and rose by 176' persons in April, down from 207' the month before. Today's weekly initial claims number is expected to show an almost full reversal of last week's spike of 25' new claims, as the larger part of the latter is expected to be due to Easter vacations. Consensus is for a decline from 429' to 410'.

Expectations about today's monetary policy meeting in the UK have changed during the past few months. Tuesday's news that UK manufactures, one of the locomotives in the British upturn, is experiencing a significant decline in activity led to a marked depreciation of the pound sterling that continued yesterday. After a series of above-expectation inflation and an increasingly hawkish tone from the MPC, many (including us) believed that the May meeting could be the scene of the first hike since the financial crisis. However, the latest key indicators shows that activity has slowed more than expected, and inflation has increase less than feared. Consequently we do not believe that Bank of England will move at this meeting. According to Bloomberg 1 of 43 expect a hike today. The market pricing indicate expectations of the first hike coming in December.

In Norway, the two important indicators gave a diverging impression of the development in the economy. The NOK weakened when retail sales fell by 0.6% m/m in March. Consensus was for a 0.5% rise. Goods consumption has fallen by 0.7% q/q in Q1, which is clearly weaker than Norges Bank's expectations. The disappointing development must be seen in light of the reduced purchasing power of Norwegian households in the wake of surging electricity expenses this winter. This effect will unwind going forward, and with solid income growth and still-low interest rate expenses, there is reason to expect an upturn in consumption. Meanwhile, the improvement in the Norwegian labour market is continuing to exceed expectations. The labour force study in February (average January-March) showed a decline in unemployment from 3.3% to 3.1%. The decline is due to a solid lift in employment, which rose by 7 000 persons in the same period. The economic growth is now strong enough to make the firms look for more employees to be able to meet the increased demand.

In sum: we still believe that an aggressive Trichet, the improvement in the labour market and signals of a strong wage settlement will weigh heavier on the scale than the strong NOK and weak retail sales when the MPC meet next Thursday. We believe that the key policy rate will come up by 25 basis points in May. We expect today's summary from Norges Bank's phone survey among firms in their Regional Network to confirm that production growth is solid, that employment is on the rise and that there are plans of increased investments – as reported in the February survey.