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Wednesday July 20, 2005 - 11:17:22 GMT
Mellon Bank Foreign Exchange -

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Forex: Mellon FX Daily - U.S. Edition

Key Points
• Impressive bounce in EUR suggests market may not be ready for fresh EUR-USD downside just yet.

• USD-JPY upside still looks attractive after yesterday’s break.

• GBP recovers after initial MPC minutes shock.

• Greenspan the major focal point today.

Market Outlook

GBP was hit by the revelation in the latest MPC minutes of a close 5-4 vote against a 25bp rate cut at the July 6-7 meeting. One of the main features of the MPC minutes were the references made to the GDP revisions released the week before the meeting. These had pushed the level of output higher in prior years, but had dragged it down since the middle of 2004. In other words, prior inflation pressure was stronger than previously thought, although the more recent output trend was much weaker than they had been led to believe. The latter was the key argument utilised by those voting for a rate cut, as they saw such a development as implying a softer outlook going forward.

However, the small majority were less convinced that the current weakness in consumer spending would persist. They also thought that the implications of the GDP revisions were best left to a fuller analysis that could be conducted as part of the August Inflation Report. A couple of 25bp rate cuts now seem likely, but it would still appear that many MPC members are far from convinced that current economic weakness will persist for that much longer. Overall, the headline 5-4 vote was not perhaps as shocking as it initially looked and cable has managed to recover after the heavy losses initially incurred. Indeed, the reaction in the money market was more subdued, reflecting the fact that a fair degree of monetary easing is already priced in. March 2006 short sterling is currently at 4.19%. Above 1.7427 on cable would allow a further recovery, while below the recent low at 1.7311 is required to set the alarm bells ringing again.

EUR-USD has continued to demonstrate strength in Asia and Europe, following the sharp recovery seen yesterday early in the US afternoon. The bounce only takes it back to where it was on Friday, but the sharpness of the recovery was nevertheless impressive, making new highs for this week’s trading.

It possibly reflects the fact that the overall news flow, while still positive for the US, has clearly turned less negative for the EUR. This not only relates to the stabilisation in some of the economic data, symbolised by yesterday’s ZEW improvement, but also the growing optimism about a change in the political climate in the Eurozone. In Germany, the CDU’s Merkel looks like winning the September election, while in France, Sarkozy is a clear favourite for the Presidential election in 2007. This is all long-term stuff and the onset of more vigorous reform in the Eurozone will still be difficult to enact and will also probably bring short-term hardship in the form of job losses and constraints on ECB rates. On this basis, it may be difficult for this to impose itself as a major positive in the short-term, but the longer-term prospects for the EUR are looking brighter.

Today sees Greenspan’s testimony on monetary policy (see below for preview). EUR-USD should fall back ahead of the testimony, although the recovery powers demonstrated yesterday make us less confident in forecasting a break on the downside over the next week or so. This may require a further affirmation of US cyclical strength, perhaps in the form of a further strengthening in the ISM and employment reports. 1.1950 needs to break to demonstrate downside potential. USD-JPY still looks good while above the previous high of 112.56 – scope up towards 114-115.

Day Ahead
US – Greenspan’s semi-annual policy testimony is likely to paint a picture of ongoing non-inflationary growth. There will be warnings about the impact of oil prices, although as he has noted on other occasions, the economy has coped with higher energy prices reasonably well thus far. The implication will be that rate hikes are set to continue and at this stage there may be little upside in him getting into any detail about how far rates will rise and/or what could constitute a neutral funds rate. There is little to be gained in him being controversial as he is probably quite happy with the rate profile currently in place in the money market, even if he is less comfortable with the level of yields further down the curve. Indeed, the latter may prompt him to err on the side of hawkishness in today’s address.

Data/event EDT Consensus*

US ABC consumer conf (w/e Jul 17) -9 -11 last
CN GDP (Q2) y/y +9.5% +9.2%
CN CPI (Jun) y/y +1.6% +1.8% last
GB MPC minutes (Jul 6-7 meeting) 5-4
GB PSNCR (Jun) £5.9bn £6.0bn
GB BBA mortgage lending (Jun) +£4.6bn +£4.3bn last
EU Trade balance (May, prel sa) €3.2bn €3.6bn
IT Ind orders (May) y/y -0.2% -0.8%
* Consensus unless stated

Latest data Actual Consensus*
CA Wholesale sales (May) m/m 08.30 +0.5%
US Greenspan’s semi-annual policy testimony 10.00
JP Trade balance (Jun, sa) 19.50 Y579bn

2005, Mellon Financial Corporation Note: Although obtained from sources believed by us to be reliable, Mellon Financial Corporation and its affiliates cannot guarantee the accuracy or completeness of the information upon which this report is based. This report does not purport to disclose the risks or benefits of entering into particular transactions and should not be construed as advice in any specific instance. The views in this report constitute our judgement as of this date and are subject to change without notice.
Ian Gunner 44 20 7163 5996 06.40 EDT Monday May 31 2005


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