THE euro closed up for the fifth week in a row setting yet new multi-year highs against the dollar on Friday. News over the week-end of the capture of former Iraqi President Saddam Hussein did afford the greenback a boost, but that was temporary, as markets focused on the overhangs of a gaping US current account deficit and low interest rates.

Traders assigned the initial dollar rally on views that Hussein?s arrest would bolster US consumer confidence whilst also curbing the rise in oil prices if the US managed to restore peace in Iraq. However, many noted that Hussein?s capture will not put an end to terrorism, nor would falling oil prices dramatically contract the economy?s huge current account deficit.

The impact of the news on the greenback was thus short-lived. Earlier, the dollar was even trounced by its own US Treasury Secretary. Speaking in New York on Friday, John Snow expressed little concern about the dollar?s slide. He said the dollar?s decline had been ?orderly? and was still high on a trade-weighted basis. The article noted the US administration saw the need to reduce the current account deficit and an orderly depreciation was seen as part of the process. Elsewhere, the FOMC kept rates unchanged and left the phrase ?considerable period? in the text, when pointing to how long interest rates might remain at current multi-decade lows.

The latest October 28?s meeting minutes in fact stated that if the economic performance were in line with the FOMC?s expectations, the large margins of unemployed labour and other resources would not be fully eliminated nor would significant inflationary pressures be seen until well into 2005 or even later. The minutes thus shifted rate hike expectations even further out.

Geopolitical risk

The news surprised a market already disappointed by the poor 5 and 10-year bond auctions this week. The 2-year note fell 11 bp following the news. The March and April Fed funds futures contracts firmed, further reducing the odds of a Q1 hike. The June and July contracts had an even more dramatic rally, implying just a 25bp hike in H1. Against the Mauritian rupee, the common currency was trading at MUR 33.38 as compared to MUR 33.36 a week earlier.

The yen retreated slightly against the dollar on Monday, with vice-Finance Minister Zembei Mizoguchi capitalising on the euphoria surrounding the arrest news to present the dollar in brighter lights.

Mizoguchi commented Hussein?s arrest helped to clear part of the geopolitical risk, allowing markets to focus back on economic fundamentals, which for the US, were strong, according to the Japanese official. Japan has, for the past few years unequivocally supported a strong dollar, or in other words, a weak yen in an endeavour to pull the Japanese economy out of recession through cheap exports.

In fact last Wednesday, the authorities were strongly thought to have intervened in the market, selling some 1 trillion yen ($ 9 billion) against the dollar in order to bring the price of the yen down in the market. Japan conducted almost 18 trillion yen of yen-selling intervention in the first 11 months of this year, and December figures due at the end of this month are expected to show record intervention levels again.

Yesterday, the Japanese currency was offered at MUR 25.17 as compared to MUR 25.51 on last Tuesday.

Sterling hovered near 11-year highs versus the greenback last week, briefly breaching the $1.75 level. The pound has been taking its cue from the dollar?s woes, as well as benefiting from a higher-yield attrait. These factors took the currency at levels last seen in the wake of Britain?s withdrawal from the European Exchange Rate Mechanism on September 16,1992. Markets will be braced for this week?s raft of data, including inflation, retail sales and unemployment, so as to make a view on the next likely hike in British interest rates. The Bank of England became the first among G7 central banks to raise rates this year, after it increased its repurchasing rate by 25 bp to 3.75% on 6 November 2003. Yesterday, the pound was trading at MUR 47.27 as against MUR 47.39 on last Tuesday.

Major data/events this week:

Wed 17 December GB ILO unemployment, EZ industrial production

Thu 18 December Ger Ifo index, GB retail sales, US jobless claims

Fri 19 December Ger PPI

Mon 22 December Ger import

Tue 23 December EZ balance of payments