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Wednesday January 25, 2006 - 12:24:05 GMT
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Forex: Mellon FX Daily - U.S. Edition

Key Points
• EUR supported by much stronger than expected German IFO, but only modest gains thus far.
• US existing home sales will also be important for the USD today.
• Chinese central bank talks about CNY band/FX reserves.
• UK MPC minutes 8-1, UK GDP slightly stronger.
• Norges Bank and RBNZ policy outcomes also feature today.

Market Outlook

The German IFO was much stronger than expected, with the headline index reaching 102.0. Apart from the 102.5 recorded in May 2000 it is the highest level recorded since November 1991. This does not sit well with the fact that ECB rates are still only 2.25%. There were rumours of a strong number (100-plus) just before the release so it was five minutes or so before EUR-USD started to move higher. However, while making a high of 1.2324 it basically failed to significantly break through yesterday’s high at 1.2322 and it subsequently traded lower. Nevertheless, this data will provide additional support for EUR-USD after the price action seen so far this week. As it currently stands, EUR-USD has risk up towards the 1.2500 area, with intermediate resistance at 1.2325 and 1.2360. Key support is at 1.2170-85, although intra-day supports are at 1.2250 and 1.2210. Together with today’s US existing home sales data, the IFO report could potentially have a strong bearing on relative interest rate expectations in the US and the Eurozone (see below for preview of home sales).

China revealed strong GDP data and a Chinese central bank official announced that the authorities would make better use of the daily trading band (if necessary) rather than make any direct revaluations. The market has slowly come round to this view anyway in recent months, although it offers support to the idea that 2006 will see a faster pace of USD-CNY depreciation. This is supported by the ongoing strength in the economic data. We currently forecast 7.60 for end-2006. The same official also said recent speculation about FX diversification had been wide of the mark, but said that they had already been appropriately diversifying reserves over the years. This will help support the notion that nothing dramatic is currently planned, but clearly leaves open the likelihood of USDs being sold for EUR as new USDs come through the central bank’s door. This is required merely to maintain the existing currency mix.

In the UK, the MPC minutes revealed another 8-1 decision and apart from the dissenter Nickell there doesn’t seem to be much urgency to change rates anytime soon. Unless there is something unusual in the data in the very short-term, this state of affairs could persist until May at least. A May rate cut still looks likely given the risk that recent consumer spending strength subsides. Q1 GDP was a touch stronger than expected and along with the steady MPC message this helped EUR-GBP lower. However, 0.6860 and 0.6840 need to break to keep this going and even then it remains well within the current range at 0.6810-0.6910.

Day Ahead
Norway– the Norges Bank meets today and looks set to leave rates unchanged. A few weeks ago some (ourselves included) had speculated that this meeting would possibly be one where the Norges Bank signalled a faster pace of monetary tightening, as opposed to the ’small, not too frequent steps’ approach adopted back in June. However, the much weaker than expected core CPI data would appear to have forestalled such a development. Still, most of the other data releases have been consistent with brighter economic developments, so they are likely to leave the ground clear for a rate hike at their next meeting, which is not until March 16. The next major event for the NOK will be the CPI data on February 10, as this will show whether or not the weakness in Dec CPI was merely a one-off. The answer to this question will have a significant bearing on future rate expectations and the NOK.

US - existing home sales is released today and is a potential market mover. Both measures of home sales were weaker last month, although in the case of new home sales this was after a very strong number in October. If there were a further decline in December this would raise fears that housing market weakness is about to develop, albeit from very strong levels. If this was to happen it would reinforce sentiment about rate hikes finishing in the months ahead.

New Zealand – the RBNZ announce their latest rate decision this afternoon and are likely to leave rates unchanged. However, they will also most probably repeat recent warnings about future weakness for the currency and the economy. This could be a difficult environment for the NZD and there is a risk of a further decline – key support at 0.6700. 0.6875 is the significant level to look at today, as this will determine whether the recent recovery can extend any further.

Data/event EDT Consensus*

NO Norges Bank policy outcome 08.00, press conf 08.45 2.25%
US Existing home sales (Dec) 10.00 6.90m
EU ECB’s Trichet speaks 10.30
NZ RBNZ rate announcement 15.00 7.25%
JP Trade balance (Dec, sa) 18.50 Y740bn
JP CSPI (Dec) y/y 18.50 -0.3%

Latest data Actual Consensus*
US ABC consumer conf (w/e Jan 23) -9 -13 last
AU CPI (Q4) q/q +0.5% +0.6%
AU CPI mkt prices ex-volatile (Q4) q/q +0.5% +0.7%
AU CPI mkt prices ex-volatile (Q4) y/y +1.8% +2.0%
CN GDP (Q4) y/y +9.9% +9.5%
CN CPI (Dec) y/y +1.6% +1.4%
DE Import prices (Dec) y/y +6.8% +6.6%
FR Ind outlook (Jan) 1 0
FR Business climate indicator (Jan) 103 103
SE Trade balance (Dec) SEK7.0bn SEK10bn
IT Consumer confidence (Jan) 106.4 108.2
DE IFO index (Jan) 102.0 99.8
DE IFO current (Jan) 100.4 99.8
DE IFO expectations (Jan) 103.6 99.8
IT Retail sales (Nov) y/y +1.7% +0.3%
GB Jan 4-5 MPC meeting minutes 8-1 8-1
GB GDP (Q1, 1st est) q/q +0.6% +0.5%
ZA CPI (Dec) y/y +3.6% +3.5%
ZA CPIX (Dec) y/y +4.0% +3.8%
* 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 d..isclose 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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