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Thursday March 9, 2006 - 12:00:35 GMT
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Forex: Mellon FX Daily - U.S. Edition

Key Points
• BoJ changes quant policy but keeps zero rates and adopts 0%-2% reference rate for inflation.
• BoJ policy change should promote calm for many markets and ultimately a weaker JPY.
• However, USD may under perform other currencies against the JPY in this environment.
• RBNZ argues for weaker NZD, but NZD may be supported today by calmer global market sentiment.
• US trade data feature today.

Market Outlook

The BoJ policy announcement - zero-percent interest rate target and 0-2% inflation reference range - is extremely palatable to markets and politicians and should ensure some recovery in Japanese equity prices and eventually a weaker JPY. It should also help to soften some of the uncertainties lying behind the weakness seen in higher risk assets – equities, emerging currencies and commodities - during the course of this week.

The BoJ said that they had decided ‘to change the operating target of money market operations from the outstanding balance of current accounts at the Bank to the uncollateralized overnight call rate’ and that the inter-meeting guideline for this policy would be to encourage the call rate to ‘remain at effectively zero percent’. This is a softer outcome than the story circulating last week that they would seek to cap the o/n rate at 0.1%.

They said that the ‘outstanding balance of current accounts at the Bank of Japan will be reduced towards a level in line with required reserves’ – which is Y6trn. However, because the policy has been in place for such a long period, they said ‘the reduction in current account balances is expected to be carriedout over a period of a few months’.

On future policy they said, ‘there will be a period in which the overnight call rate is at effectively zero percent, followed by a gradual adjustment in the light of developments in economic activity and prices.’ They added that if inflation pressures are restrained ‘an accommodative monetary environment ensuing from very low interest rates will probably be maintained for some time.’

On outright purchases of JGBs they said that such ‘purchases will continue at the current amounts and frequency for some time, with due regard for future conditions of the balance sheet of the Bank.’ The exiting of this policy will be a source of some problems in the future, but will probably be overlooked by the market for the time being.

They also made a separate announcement regarding the future policy framework, especially with regard to defining price stability. ‘It was agreed that…an approximate range between zero and two percent was generally consistent with the distribution of each Board member's understanding of medium to long-term price stability. Most Board members' median figures fell on both sides of one percent.’ They added, ‘Given that the understanding of medium to long-term price stability may change gradually reflecting developments such as structural changes in the economy, as a rule, Board members will review it annually.’

Overall, the whole package is well balanced and cautious and while sensitive decisions will inevitably need be to made at some point in the future, these have been deferred for now and the BoJ has managed to get itself over the first hurdle of policy adjustment without calamity. This should help Japanese equities and weaken the JPY.

However, while the JPY weakened initially on the news, it recovered fairly sharply once the European session got into full swing. There are two ways of looking at the situation a) there are many months to come of very low or zero interest rates or b) that this is the beginning of the end of the zero rate policy. The old glass half full or glass half empty problem. Ultimately, we would see this as JPY negative, although downside may be more limited than it would otherwise have been and sentiment may become more sensitive to economic data and the possible timing of future policy adjustments.

On USD-JPY, the slip below 117.30 this morning was disappointing and this level at least needs to be won back to offer some hopes for the upside. 117.55, 118.00 and 118.30 (o/n high) are intermediate levels ahead of 118.50. 118.50 will need to break to get the market excited about upside and a possible test of 119.50-120.00. However, insofar as this environment may reduce or reverse the recent flow back into the USD investor base, other currencies than the USD may have better prospects against the JPY. 141.10-40 will be key on EUR-JPY. EUR-USD should also improve today, although 1.1975 will need to break to see any meaningful gains and the market may remain a little wary about chasing it higher given the false starts of the past week. US trade data will also exert an influence today.

The BoJ was not the only CB in action overnight. The RBNZ left rates unchanged as expected and said that ‘recent data have confirmed our earlier view that economic growth is slowing’. They noted that growth was likely to remain subdued over the coming two years while a major rebalancing (recovery in net exports, weaker domestic demand) takes place. They also said that a ‘decline in the NZD is expected to play a role in this rebalancing.’ They concluded by saying that as long as inflation risks remain under control they would not be raising rates again in the current cycle, but suggested that because it would take some time for inflation to return to the mid-point of the target they did not expect to ease policy this year.

The mention of the NZD in the statement will maintain the overall downward pressure on the NZD, although there may be some short-term support today because of the likelihood of a calmer market environment in general post-BoJ. In the very short-term which ever end of a 0.6470-0.6540 range breaks first will stimulate trading direction accordingly.

Day Ahead
The UK MPC are likely to leave rates unchanged and this is well anticipated by the market. Monthly trade data is due in theUS. The deficit has been more stable in recent months after the sharp widening seen in September and this has probably continued into January. However, there is always the risk of a wider deficit given ongoing solidity in US domestic demand.

Data/event EDT Consensus*

GB MPC rate announcement 07.00 4.5%
CA New house prices (Jan) m/m 08.30 +0.5%
US Trade balance (Jan) 08.30 -$66.5bn
US Initial claims (w/e Mar 4) 08.30 293k
US Continuing claims (w/e Feb 25) 08.30 2486k last
CA Trade balance (Jan) 08.30 C$7.4bn
JP Domestic CGPI (Feb) y/y 18.50 +2.7%
GB NIESR GDP (3mths to Feb) q/q 19.01 +0.8%
AU Housing finance (Jan) m/m 19.30 +1.0%
JP Overall PCE (Jan) y/y 00.00 -2.9%
JP Machinery orders – core (Jan) m/m 00.00 -5.2%

Latest data Actual Consensus*
NZ RBNZ rate announcement 7.25% 7.25%
AU Employment (Feb) 25.9k +10k
AU Unemployment rate (Feb) 5.2% 5.3%
CH CPI (Feb) y/y +1.4% +1.2%
SE Ind prod (Jan) m/m +1.7% +0.5%
SE Unemployment rate (Feb) 5.2% 5.3%
GB Ind prod (Jan) m/m +0.4% +0.2%
GB Manu output (Jan) m/m +0.2% +0.2%
GB Global trade balance (Jan) -£5.7bn -£5.8bn
GB Non-EU trade balance (Jan) -£3.7bn -£2.9bn
DE Ind prod (Jan) m/m -0.1% +1.0%
* 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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