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Wednesday August 10, 2005 - 13:04:35 GMT
Mellon Bank Foreign Exchange -

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Forex: Mellon FX Daily - U.S. Edition

Key Points
• FOMC maintains similar message to past meetings – more tightening to come.

• EUR-USD retains upside bias, but will need to move soon.

• JPY receives boost from polls suggesting increased support for Koizumi.

• UK Inflation Report aids GBP.

• US monthly fiscal data feature today.

Market Outlook

The FOMC hiked rates by 25bp to 3.5% and said that policy was still accommodative (the risk of an adjustment in the ‘accommodation’ language will remain in place for the meetings ahead). They also said that aggregate spending had improved since the winter months despite high energy prices, but made no direct reference to the very latest rise in oil prices. They noted that labour market conditions had continued to improve gradually and that while core inflation and inflation expectations had been low in recent months, the pressures on inflation were still elevated. There is no indication from these statements that the FOMC is contemplating any near-term end to monetary tightening. On the face of it the tone of the message was USD supportive, although the bigger issue is whether the USD’s recent correction lower has yet run its course. A number of currencies have advanced against the USD overnight, pushing the USD index below the June low of 87.61.

EUR-USD twice shied away from 1.24-plus levels in Europe yesterday, although rather than being a sign that the recent correction was running out of steam, this may have merely been due to pre-FOMC angst. Trading today should reveal underlying preferences and thus far it has been shaping up positively for EUR-USD. Upside is still favoured in the short-term as the correction plays out, but it will need to get a move on, otherwise momentum will be lost. 1.2450-1.2500 is the main area overcome short-term. Initial important support comes in at 1.2301 ahead of the key 1.2250-60 area. Below there would pretty much confirm that the correction is over.

The JPY looks better this morning with the main boost coming from two opinion polls showing public support for Koizumi’s cabinet rising since he dissolved the Lower House. An Asahi Shimbun poll had support up to 46% from 41% last month, while a similar poll in the Mainichi Shimbun had support for him rising to 46% fro 37%. This is good news for Koizumi and will give him confidence to press ahead with cleansing the LDP of its anti-reform rebels. If he can do this there is every chance of him retaining governmental control after the election and reform prospects will be better for the experience, boosting the JPY. If 110.75 gives way today, this would signal more JPY strength.

In the UK, the Inflation Report helped to downplay the notion of a further cut in rates before the next Inflation Report in November. The forecast saw GDP weaker in the short-term but recovering to 3% beyond that, while the MPC also produced some interesting forecast profiles for CPI. Under the assumption of the current repo rate of 4.5% they forecast CPI weaker in the short-term then recovering to the 2% target in two years and on a rising trajectory. However, using market interest rate expectations as an assumption gave CPI around 2.25% in two years and rising further in the third year. Given their remit of achieving a 2% target, these profiles (intended or not) strongly suggest that they are not currently in a position to cut rates any further. In this regard short-term rate cut risk has abated further for GBP and this should allow some further independent strength for GBP in the next couple of days. On cable, much will depend upon the USD in general, but there is easy scope to 1.80. On EUR-GBP, a test of 0.6875 looks likely and below there would open things up to 0.6840.

How GBP fares beyond this in the weeks ahead will depend upon the data, particularly next week’s retail sales number. King did say that the risks to the CPI and growth forecasts were to the downside, suggesting clear room for a further downgrade in forecasts by the time of the next Inflation Report and one more rate cut, which remains our favoured scenario. Also note that King said there had been signs that the consumer sector was recovering, although if he is basing this on the strength of the June retail sales number, this could easily be reversed in July. The June data was mostly likely boosted by early summer discounting, meaning that July could be very weak.

Day Ahead
US – the July monthly budget data is due later today and recent numbers have been encouraging. Last month, the cumulative deficit for the Oct04-Jun05 period stood at $249.8bn compared to $327.2bn in the first nine months of the previous financial year. This coincided with the government cutting its overall deficit forecast for this fiscal year to $333bn from their February forecast of $427bn (the deficit for the whole of the last fiscal year was $412bn). Last July there was a deficit of $69.2bn and the market is looking for an improvement on this.

Data/event EDT Consensus*

CA New house prices (Jun) m/m 08.30 +0.4%
US Federal budget balance (Jul) 14.00 -$56.7bn
NZ Unemployment rate (Q2) 18.45 3.9%
JP Current account (Jun, sa) 19.50 Y1.4trn
AU Employment (Aug) 21.30 5.0%
AU Unemployment rate (Aug) 21.30 -2.5k
CN CPI (Jul) y/y n/a +1.5%

Latest data Actual Consensus*
US FOMC meeting outcome 3.5% 3.5%
US ABC consumer conf (w/e Aug 7) -8 -11 last
JP Domestic CGPI (Jul) y/y +1.5% +1.3%
AU Consumer sentiment (Aug) +7.6% -5.5% last
FR Ind prod (Jul) m/m +0.3% +0.4%
FR Manu output (Jul) m/m +0.3% +0.3%
NO CPI (Jul) y/y +1.4% +1.8%
NO CPIX (Jul) y/y +1.1% +1.2%
* Consensus unless stated

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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