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Friday March 3, 2006 - 12:17:46 GMT
Mellon Bank Foreign Exchange -

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Mellon FX Daily - U.S. Edition

Key Points
• EUR-USD well underpinned after technical break and ECB stance.
• ECB response today (if any) will be crucial in terms of validating or modifying yesterday’s general
interpretation of events.
• JPY reaction to strong data suggests market is comfortable with future BoJ policy environment i.e. the continuation of very low interest rates.
• Service sector surveys strong in Eurozone and UK.
• Non-manufacturing ISM and Michigan sentiment feature in the US.

Market Outlook

A big day for the EUR yesterday, with the ECB providing a fairly hawkish message and EUR-USD breaking above some important technical levels. In contrast to past presentations on policy, Trichet was not making any apologies for the latest rate hike. Indeed, while he did say that there were downside risks to growth because of high-energy prices and global imbalances, the upside risk to price stability he also mentioned would appear to be more pressing given the upgrades to staff CPI and GDP forecasts. CPI is now forecast at +2.2% for both 2006 and 2007 compared to +2.1% and 2.0% respectively in the forecasts made in December. What yesterday’s comments have done, and perhaps this was intentional, is to push the door gently open for another hike before June, which was previously seen as the most likely time for the next move. The prospects for where rates will be at the year-end have also been boosted.

Of course, given the downward pressure felt by equity markets yesterday and the hawkish interpretation by the media and markets in general, there is always a chance that the ECB tries to backtrack somewhat in the short-term, if they feel that the market has gone too far. This is a potential danger for the EUR, as the ECB is no stranger to this sort of intervention, but because of this tendency, any failure to offer corrective comment will be equally significant and will validate the market’s current interpretation of events. If they are going to say anything it will most probably be today or at the weekend. Unless there is a change of tack from the ECB, EUR-USDshould be well supported above the previous highs at 1.1970-75. Furthermore, the break above the 100-day movingaverage (1.1941 yesterday) is also significant. As mentioned recently, this indicator has been highly significant for both shortand medium term EUR-USD trends over the past year whenbreached (up or down) on a closing basis. 1.2050 is the main barrier to get through today to keep the upmove going and some very strong US data will be required to prevent thishappening given the way momentum is currently developing.

In Japan, the core measure of CPI came out stronger than expected at +0.5%, while labour market numbers, other than the unemployment rate itself, were also very encouraging. However, while USD-JPY initially spiked lower on the release (trading below 115.60), it quickly recovered and within 90 minutes it was back above 116.60. It has since fallen back, but overall the price action demonstrates that the market has become much more comfortable about what the BoJ policy environment will look like over the medium-term. On the basis of recent information coming out of official discussions (cap on o/n rate, reference value for CPI) it seems likely that the period of very low interest rates in Japan will last for some time yet. The market is now perhaps sensing that when this is confirmed in the wake of any adjustment to quantitative targets (possibly as soon as next week) the JPY could weaken afresh and we would agree with this scenario. Some upside could be seen on USD-JPY today, although position building may be tentative ahead of next week’s BoJ meeting. Resistance is at 116.75- 117.20.

Day Ahead
US – Michigan sentiment and non-manufacturing ISM data is due today and strong numbers will be required to offer support for the USD. Michigan sentiment is well off the lows seen around the time of the hurricanes, but last month slipped below the averages seen earlier in 2005. Non-manufacturing ISM was also disappointing last month, falling back to 56.8, which while fairly respectable is still the second lowest showing since April 2003 (Iraq war). September just gone (hurricane affected) was the lowest since April 2003 at 53.7.

Data/event EDT Consensus*

US Michigan sentiment (Feb, fin) 09.45 87.6
US ISM non-manu (Feb) 10.00 58.0

Latest data Actual Consensus*
JP CPI Tokyo (Feb, core) y/y +0.2% +0.2%
JP CPI Nwide (Jan, core) y/y +0.5% +0.4%
JP Unemployment rate (Jan) 4.5% 4.4%
JP Job-to-applicants ratio (Jan) 1.03 1.01
JP Employment (Jan) +270k -40kR last
JP PCE workers (Jan) y/y -4.7% -1.3%
AU Trade balance (Jan) -A$2.7bn -A$1.3bn
IT PMI services (Feb) 57.7 56.0
FR PMI services (Feb) 60.1 57.5
DE PMI services (Feb) 57.8 58.3
EU PMI services (Feb) 58.2 57.2
GB PMI services (Feb) 58.9 57.1
EU GDP (Q4, prel) q/q +0.3% +0.3%
* 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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