Trichet Signaled April Hike, Backed by ECB Chorus, EUR/USD Breached

EUR/USD surged sharply higher last week and breached 1.4 level as markets' rate speculations was further affirmed by ECB President Trichet's hawkish messages. While the ECB left the main refinancing rate unchanged at 1%, Trichet signaled an 'increase of interest rates in the next meeting is possible' and 'strong vigilance is warranted'.

Also, the reference that interest rates are 'appropriate' was taken out from the press statement. The ECB staff revised up forecasts for economic growth and inflation. Annual real GDP will expand in a range between 1.3-2.1% in 2011 and between 0.8%- 2.8% in 2012. The lower ends of the ranges have been lifted when compared with December's estimates. As a result of 'considerable rise in energy and food prices', the ECB also revised up its inflation forecasts. Annual HICP inflation will probably grow in a range between 2-2.6% for 2011 and between 1-2.4% for 2012. 

The signal for an April hike was also supported by other ECB officials. France Noyer said that "some question marks start to arise that some pressure for second-round effects develops, that some pass-through is being seen," and "We need to reaffirm very strongly that we will never let that happen." ECB Executive Board member Bini Smaghi warned that failure to lift borrowing costs in response to faster headline inflation would make the monetary policy stance "more accommodative" and "over time fuel core inflation." Gonzalez-Paramo said "the risks to inflation are on the upside and it is the mission of the ECB to prevent those from materializing". Cyprus Orphanides said central banks must be "pre-emptive" in fighting inflation. Meanwhile, German Chancellor Merkel said that "irrespective of the questions of the ECB and interest rates, we know that we have to put a joint package for the euro on the table" to take the debt crisis. Luxembourg Prime Minister Jean- Claude Juncker also said "that has nothing to do with the question of interest rates."

On the other hand, dollar failed to ride on positive economic data and was sold off against European majors. Both ISM manufacturing and non-manufacturing indices rose to 7-year highs in February. US' employment data have improved further. Non –farm payrolls unexpectedly added 192K in February while January's reading was revised up to +63K. Unemployment rate surprisingly slipped to 8.9% in February from 9% in the prior month. Bernanke downplayed the significance of recent jump in oil prices, signaled he would keep QE2 until expiry in June and refused to rule out the possibility of further QE measures. Bernanke said recent recent surge in commodity prices "not yet pose a significant risk" and "oil prices alone would probably not be enough to make us respond."

In additional, the greenback was pressured by the surge in commodity prices as gold made new record high while oil jumped to as high as 104.94, a level not seen since September 2008. Geopolitical tensions in the Middle East and North Africa remained the main driving force in crude oil's rally. Ease in concerns over oil supply disruption was short-lived as Libyan rebels rejected the peace deal offered by Venezuela. It's reported that protesters have moved westward and threatened to damage the central oil port of Ras Lanuf. Oil prices surged on worries that the unrest will spread to other oil-rich countries.

Elsewhere, Sterling's rally against dollar halted on pressured in cross selling against Euro and markets are now expecting ECB to hike earlier than BoE. Swiss franc was helped by risk aversion and comments from SNB Jordan that "low interest rate level is not sustainable in the medium and long term." Canadian dollar managed to ride on strength in oil prices and after BoC delivered a more hawkish tone in March than previously despite no change in the policy rate. Australia dollar failed to strength in spite of strength in Gold. RBA kept the cash rate unchanged at 4.75% and delivered a neutral tone as policymakers see balanced risks to growth and inflation outlook. Also, for the first time in the current tightening cycle, the RBA stated that the current stance of monetary policy is 'mildly restrictive'. New Zealand dollar was the weakest currency as markets are expecting a rate cut from RBNZ this week.

The Week Ahead

Two central banks will meet this week. RBNZ is widely expected to cut rates to avoid going back into recession after the worst earthquake in 80 years. BoE on the other hand, is expected to keep rates and the asset purchase program unchanged. On the data front, main focus will be on Australia and Canada employment as well as US retail sales. In addition, EU leaders will meet on Friday to hammer out the highly anticipated comprehensive package of measures to tackle the region's debt crisis, which is expected to be signed off on March 25.

• Monday: Canada building permits
• Tuesday: UK RICS house price balance; German factory orders; Canada housing starts
• Wednesday: Australia home loans; Swiss CPI; UK trade balance; German industrial production; Canada new housing price index; RBNZ rate decision
• Thursday: Japan GDP final; Australia employment; UK industrial and manufacturing production, BoE rate decision; US jobless claims
• Friday: China CPI; UK PPI; Canada employment; US retail sales, consumer sentiment