Currency converter takes lead from the ECB

The euro firmed after the European Central Bank gave a clear hint that it is still on course to raise borrowing costs next month despite the recent turmoil in the financial markets.

In a statement, the ECB confirmed yesterday that its monetary policy stance has not changed from earlier in the month when the bank's chief Jean Claude Trichet reinforced expectations of another quarter point increase in the key refi rate to 4.25 %.

His use of the code words 'strong vigilance' on August 2 was widely seen as a precursor for a rate hike. Since then, however, the troubles in the US subprime market have led to steep falls in markets around the world, and in turn leading to some doubt whether the ECB will indeed continue hiking interest rates.

As this phrase has been used to signal every rate hike in the recent cycle, this supports our view that the ECB is likely to make good its promise for a September hike. Indeed, if growth rebounds in the coming months as the surveys suggest, another hike in December, to 4.50 % is still a possibility.

While the ECB is poised to raise interest rates, the US Federal Reserve could be on course for a rate cut.

The Fed's chairman Ben Bernanke said on Tuesday that he was 'absolutely' prepared to use all the tools at his disposal to address the credit crisis in the US financial system, according to Senator Chris Dodd, chairman of the Senate banking committee. Dodd reported Bernanke's comments to the press after a closed-door meeting with Bernanke and Treasury Secretary Henry Paulson.

Elsewhere, the pound was buoyed by a much stronger than expected survey on the UK manufacturing sector.

The Confederation of British Industry revealed that a balance of +9 % of firms polled reported that their order books were above normal in August - the highest level for more than 12 years.

An imminent rate hike from the Bank of England is not expected after last week's news that annual CPI inflation dropped below the 2.0 % target to 1.9 % in July from 2.4 % in June.

Still, a return to calmer conditions in financial markets in the near-term combined with a likely acceleration in CPI inflation in Q4, due to base effects from the large decline in oil prices late last year, could still see the BoE raise rates one final time to 6.00 % by year end.

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