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Thursday March 2, 2006 - 12:07:00 GMT
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Forex: Mellon FX Daily - U.S. Edition

Key Points
• Post-quantitative easing BoJ policy framework is starting to take shape.
• Removal of uncertainty on the issue should ultimately weaken the JPY as continuation of low rate environment is confirmed, but tonight’s CPI is the near-term focus.
• EUR-USD knocked back by US ISM. Any upside testing ahead of today’s ECB outcome is unlikely to be sustained.
• USD-CAD remains soft – AUD looking better.
• US jobless claims also due today.

Market Outlook

The market is becoming slightly more comfortable with the prospect of a BoJ policy adjustment. There have been a number of stories coming out of Japan over the past 24 hours about the likelihood of the BoJ implementing safeguards to ensure that interest rates do not spike higher following any adjustment in current account balance targeting. This alone suggests that high-level discussions on the key issues are intensifying and that a policy adjustment is not far away.

One key feature is thought to be a pledge to ensure that , to cement the idea that the zero rate policy will largely stay in place while the quantitative element of the current regime is being dismantled. In addition to this there is an appreciation of the need to provide some kind of post-quantitative easing policy framework, to help guide market expectations. Most of this discussion has revolved around an inflation target, but an explicit numerical target is thought by many to be too restrictive. Furthermore, the CPI indices are likely to change in Q3 with the introduction of a new core CPI measure, which excludes energy as well as fresh food prices. A more acceptable compromise would be a ‘reference’ value for inflation rather than a strict target, in much the same way as the ECB has 2% in mind when conducting policy. This idea has been circulating in the Japanese media today and seems to be the most likely outcome for the BoJ. What does seem to be clear is that there will be a reluctance to change policy at all without such a framework in place.

Overall, when the dust settles it should become fairly clear that the very low interest rate environment is likely to remain in place for some time yet and when the market is happy with this conclusion the JPY should weaken afresh. In this regard, the sooner the BoJ makes the change the better – it is the uncertainty about what will be announced that is the major JPY positive at the current time, especially given prior short JPY positioning.

A solid looking ISM manufacturing number yesterday provided the USD with some support and this reduces the chance of a break higher in EUR-USD today or tomorrow. Of technical significance yesterday was the fact that this data brought EURUSD back down below the 100-day MA (1.1941) before the close. Closes either side of this indicator have been highly significant over the past year or so. The 1.1970-75 recent highs also remained intact yesterday and this area (whether it breaks or not) will continue to be a good intra-day indicator as to whether the 100-day MA can break on a closing basis. Some upside testing looks likely ahead of the ECB meeting outcome and press conference, although a 25bp rate hike should be fully discounted and it seems unlikely that Trichet will provide any further encouragement to rate hike expectations. Any rallies should therefore be short-lived and the market will await further direction from tomorrow’s non-manufacturing ISM data out of the US. German retail sales data for January was strong this morning, although this data series is so volatile it is too early to judge whether it is genuine or merely statistical noise.

USD-CAD remains depressed following the move below the Jan 31 low of 1.1375 and this could extend further ahead of next week’s generally expected BoC rate hike. However, the 1991 low at 1.1190 is likely to remain safe for now. A break of this level does look likely later in the year, but it may also require a change in general USD sentiment.

The AUD is also looking better after yesterday’s move above 0.7450. Last night’s stronger than expected retail sales comes after the strong private sector credit growth number earlier in the week and provides some tentative ground for the possible re-emergence of RBA rate hike expectations. However, further strength in a number of other indicators will be required before this develops with any conviction. Meanwhile, the AUD is also receiving some support from the uplift to the gold price over the past week. While above 0.7420-50 there is some risk up towards 0.7600, although this potential could be cut short if the USD were to strengthen against the EUR.

Day Ahead
Eurozone – a 25bp rate hike at today’s ECB meeting has already been discounted and the main focus will be on Trichet’s comments at the press conference. He will attempt to justify the current hike without necessarily building up hopes of aggressive moves in the future. He may reiterate the comment used at the time of the December hike that rate hikes are not pre-planned, although the market will most likely stick to the view that another 25bp move will happen at some time during Q2, most probably June. Indeed, the ECB will be reasonably content with this sort of market expectation. None of this is likely to influence the EUR too much and US data releases will probably continue as the main driving factor.

US – weekly jobless claims are out and any strength will offer support for forecasts of next week’s non-farm payrolls.

Japan – CPI and labour market data is out tonight and the market will naturally be focused on CPI. Core Nationwide CPI moved out of negative territory in October (zero) and followed that with y/y growth rates of +0.1% in both November and December. In terms of a move out of deflation this is about as tentative as it could possibly be, especially when most officials (BoJ included) still acknowledge that CPI has an upward bias. A much firmer outcome is expected on core CPI for January (+0.4% y/y) and if realised this will help to firm up expectations about an adjustment in their quantitative easing policy, possibly as soon as next week, although more likely April. Of course, any unexpected weakness in core CPI would seriously run counter to the way sentiment has been developing in recent weeks and would be JPY negative.


Dat NZ ANZ commodity prices (Feb) m/m 07.00 -0.3% last
EU ECB meeting outcome 07.45, press conf 08.30 2.5%
US Initial claims (w/e Feb 25) 08.30 285k
US Continuing claims (w/e Feb 18) 08.30 2495k last
JP CPI Tokyo (Feb, core) y/y 18.30 +0.2%
JP CPI Nwide (Jan, core) y/y 18.30 +0.4%
JP Unemployment rate (Jan) 18.30 4.4%
JP Job-to-applicants ratio (Jan) 18.30 1.01
JP Employment (Jan) 18.30 +30k last
JP PCE workers (Jan) y/y 18.30 -1.4%
AU Trade balance (Jan) 19.30 -A$1.3bn
a/event EDT Consensus*

Latest data Actual Consensus*
JP Monetary base (Feb) y/y +1.9% +1.6%
AU Retail trade (Jan) m/m +0.8% +0.3%
AU Building approvals (Jan) m/m -1.9% +1.5%
CH GDP (Q4) q/q +0.5% +0.6%
DE Retail sales (Jan) m/m +2.7% +1.0%
NO Unemployment rate (Feb, nsa) 3.0% 3.0%
EU PPI (Jan) y/y +5.3% +4.8%
* 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 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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