Foreign Currency Report 27 February 2007

Euro
Belgian National Bank governor Guy Quaden said the level of eurozone interest rates is not curbing growth, and that monetary policy is still accommodative. Presenting the central bank's 2006 report on the Belgian economy, Quaden noted that euro zone rates are historically low.

"The level of interest rates is not hampering economic activity in Europe," he told reporters. "Interest rates are still accommodative," he said. The European Central Bank's governing council is widely expected to raise rates to 3.75 pct on March 8. On the ECB's new set of economic forecasts, to be presented at that meeting, he said: "We will assess all the new information in particular, but not only inflation and we will take a decision in the next coming months," he said. Quaden said the acceleration of Belgian growth to 3 pct in 2006 from 1.5 pct the previous year is a sign of what will happen in the euro zone as a whole.

US
The housing slowdown is expected to keep U.S. GDP growth at its slowest pace in five years, but stronger consumer spending should counterbalance that drag, according to a survey at the National Association for Business Economics. The group expects the economy to grow 2.7% in 2007. Housing construction is forecast to plummet 14.9%, well ahead of the 5.5% drop the group predicted in November and the 4.2% decline in 2006. The economists expect a 3.2% rise in consumer spending, however, that should protect the overall economy. They forecast consumer prices to increase only 1.9% against a 3.2% rise last year, helped by lower energy prices. The core inflation index, though, which excludes food and energy, is forecast to rise 2.3% this year and next. The group believes the Fed will maintain the benchmark federal funds rate at 5.25% for the rest of 2007 and cut it to 5.0% in 2008; in November, it predicted two hikes this year. Once housing stabilizes, GDP should rebound to 3% in 2008. The economists identified subprime mortgage lending as the greatest risk to the financial markets.

GBP
Inflation is likely to fall sharply in the coming months and stand below the 2 percent target in two years, Bank of England Monetary Policy Committee member David Blanchflower said on Monday. In a speech in Scotland, Blanchflower said he expected inflation, running at 2.7 percent in January, to return to the target by late spring/early summer and possibly be well under by the end of the year. "My own particular view is that there is a slightly greater margin of spare resources in the economy than embodied in the central projection," he said, according to the text of his speech to be delivered at the University of Stirling, Scotland. "I therefore believe that inflation will recede more quickly and to a greater extent than the (inflation) profile and be below target at the two-year horizon." The BoE's central forecast is for inflation to stand at the 2 percent target in two years the time it takes for rate changes to work their way through the economy assuming interest rates climb 25 basis points to 5.5 percent. Blanchflower has opposed the BoE's last three interest rate hikes, constantly arguing that slack in the labour market means that tighter policy is not necessary. And his latest comments again suggest that he sees little reason for the BoE to hike interest rates again.

But he noted that other MPC members were more worried about price pressures in the economy Andrew Sentance and Tim Besley wanted to hike rates again in February when the other seven policymakers chose to keep borrowing costs pegged at 5.25 percent. Blanchflower echoed Governor Mervyn King in saying there was greater uncertainty than usual over the inflation outlook, not just because of debate over the degree of spare capacity but also the evolution of the exchange rate and the world economy.