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Thursday June 8, 2006 - 10:46:23 GMT
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Forex: Mellon FX Daily - U.S. Edition

Key Points
• Market waits for ECB outcome.
• Close call between 50bp & 25bp – the data suggests 50bp, while current market volatility suggests 25bp. 50bp is certainly the cleaner option, but some may see this as too aggressive in current circumstances.
• At the press conference it will be difficult for Trichet to suppress current hawkish instincts.
• Global uncertainty will persist whatever the ECB does, suggesting an environment where direction for the majors will remain difficult.
• Fed’s Guynn implies that all options are open for June 29.

Market Outlook

EUR-USD is trading quietly ahead of today’s ECB outcome, although whatever happens at that meeting it is unlikely that current market uncertainties will be resolved. Comments yesterday by Atlanta Fed governor Guynn confirm that the Fed will not take any chances on inflation, implying that all options were on the table for June 29. He said “If we're on target with our present forecast for growth to moderate to a sustainable pace and for inflation to fall back within acceptable bounds, I would say that monetary policy is now close to where it should be.'' Yet, “we have to remain open to rethinking our policy setting as that outlook changes.''

For an in-depth discussion of the ECB meeting see the section below, but for the short-term market reaction there are three plausible options. 1) A 25bp move and a dovish statement, in which case EUR-USD would test and most likely fall through support at 1.2685-1.2725 as positions are liquidated. 2) 25bp and a hawkish statement, in which case there will be volatility but probably not much direction. 3) a 50bp hike, in which case upside will be tested (high 1.29s/possible 1.30 plus) but probably not sustained. The problem with 50bp is that it will spook global markets and this is likely to deter specs from pursuing EUR-USD upside. As stated yesterday, the current highly uncertain environment is not one that is conducive to big directional moves on the majors. Indeed, this in itself would suggest some overall corrective downside risk on EUR-USD.

News that al-Zarqawi had been killed in Iraq pushed EUR-CHF higher but initially this was not sustained. It was only later as news about Iran’s possible willingness to negotiate started to filter through that the CHF weakened a little further. The impression on al-Zarqawi is that while his removal is a positive step, the terrorist threat in Iraq, widespread as it is, is unlikely to suddenly disappear. It seems highly likely that Al-Qaeda and al- Zarqawi will have anticipated such an event and planned for it accordingly. More important in the short-term will be how the Iranian situation develops.

More strong data out of Australia, with employment (+56k) being supported by a 55.8k rise in the full-time component. The unemployment rate of 4.9% was the lowest recorded for thirty years. Such developments, in combination with recent strength in private sector credit and retail sales increase the prospect of the RBA raising rates as early as August, depending upon what the Q2 CPI report (released late July) reveals. Ultimately, this should be a promising environment for the AUD, although it is possibly too early to jump in given current uncertainties about global markets and commodities.

UK manufacturing output data was weaker than expected and runs counter to the more positive noises coming from PMI and CBI surveys where orders (especially export orders) have been improving impressively.

Day Ahead
Eurozone – the ECB meeting and press conference are the key events today and the outcome remains a very close one. It seems clear from the more aggressive rhetoric advanced by ECB officials in recent weeks that they would like to move more rapidly on policy tightening, given that rates are at levels considered to be well below neutrality. This is why we have been opting for a 50bp rate hike at today’s meeting, especially as the ECB has in the past not shied away from moving by larger less frequent amounts. (The ECB has changed rates seventeen times since its inception and of the nine hikes, two have been by 50bp. Of the eight cuts, five have been by 50bp – all other moves being by 25bp.) However, recent developments in equity markets, signs of growth moderation in the US and the strength of EUR-USD are all factors that could lead them into choosing the softer option of a 25bp move today. Indeed, there were suggestions on newswires yesterday (from sources cited by Market News) that a 25bp move was the most likely outcome, although even that report suggested that there would be differences of opinion on how to proceed.

The problem with just a 25bp move is that it will fail to satisfy the tightening instincts that many ECB officials now harbour given the strength in key pieces of data. This not only relates to the strength of key surveys of economic activity growth, but also to the sustained acceleration in private sector lending growth and the headline CPI, which is now at +2.5%. The sharp rise in (interest rate sensitive) lending growth is evidence enough that interest rates are way too low.

In other words, if they do go for the softer 25bp option, equally as interesting will be how Trichet plays this at the press conference. There is every chance of him providing some suggestion that a further rate hike will follow at one of the next few meetings, otherwise it would suggest a dovishness on policy that is inconsistent with the remarks, signals and data developments of the past month. Of course, this is where the 25bp option gets difficult, as we are now entering the summer period where rate moves become slightly more problematic. For example, the August 3 meeting does not have any scheduled press conference, so if the ECB is to increase the pace of tightening it will have to follow with a 25bp move in July. Even the ‘September’ meeting actually takes place on August 31, which many in Europe would still consider to be part of the holiday period. Overall, a 50bp move remains the cleaner option, but whether they take it remains to be seen.

US – jobless claims data will be watched to see whether last week’s rise in initial claims is sustained. If it is it will add to evidence of a softening in labour demand.

Diary
Data/event EDT Consensus*

GB MPC rate announcement 07.00 4.5%
EU ECB meeting outcome 07.45, press conf 08.30 2.75%
CA Housing starts (May) 08.15 222k
CA New house prices (Apr) m/m 08.30 +0.5%
CA Productivity (Q1) q/q 08.30 +0.4%
US Initial claims (w/e Jun 3) 08.30 330k
US Continuing claims (w/e May 27) 08.30 2433k last
ZA SARB rate announcement 09.00 7.0%
GB NIESR GDP (3mths to May) q/q 19.01 +0.6% last

Latest data Actual Consensus*
US Consumer credit (Apr) +$10.6bn +$3.5bn
NZ RBNZ rate announcement 7.25% 7.25%
JP M2 plus CDs (May) y/y +1.4% +1.8%
JP Bank lending (May) y/y +1.2% +1.3%
AU Employment (May) +56k +12.5k
AU Unemployment rate (May) 4.9% 5.1%
CH Unemployment rate (May, sa) 3.4% 3.4%
GB HBOS house prices (May) m/m +0.1% +2.0% last
NO Manu output (Apr) m/m -1.5% +0.5%
GB Ind prod (Apr) m/m -0.6% +0.3%
GB Manu output (Apr) m/m -0.2% +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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