DOLLAR’S FATE IN THE HANDS OF MR TRICHET

AT THE start of this week’s trade in the currency market, the much beleaguered dollar received an unexpected lift when President Obama announced that a top notch team of Navy Seals was able to find and kill Osama bin Laden. However by the North American open, most of the patriotic sentiment had faded and the buck resumed its downward trend as both euro and Aussie hit fresh year-to-date highs against the unit.

Despite the boost from geo-political events, the trade in the dollar continues to be driven almost exclusively by economic factors. Last week, Ben Bernanke confirmed that the Federal Reserve will remain stationary at least until the end of 2011, leaving the buck vulnerable to further selling on carry trade flows as interest rate differentials between US and the Eurozone continue to widen.

That’s why any recovery in the dollar will not be driven by US policy manoeuvres, but rather by actions of the monetary authorities on the other side of the Atlantic. Therefore this Thursday’s European Central Bank (ECB) meeting at 12:30pm could prove pivotal to the near term direction of euro-dollar. With the currency market primed for further rate increases, any suggestion by ECB chief Jean Claude Trichet that the European authorities may not hike rates for at least a few more months could trigger a profit taking rally in the pair.

Although European monetary policy makers continue to be concerned about inflation, they are also wary of driving euro-dollar higher, fearing that above the $1.5000 level it could hurt exporters in the region. Furthermore, if oil prices, which are the primary catalyst behind rising price levels, begin to stabilise around the $110/bbl level, the ECB may feel less need to be vigilant.

On Monday, European Central Bank vice president Vitor Constancio may have tried to telegraph the policymakers’ intentions by stating that, “we have not decided to rush into a series of further increases.” If Jean Claude Trichet echoes that sentiment, euro-dollar could correct towards the $1.4500 level over the next several weeks.