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Thursday August 3, 2006 - 10:36:49 GMT
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Mellon FX Daily - U.S. Edition

Key Points
• EUR-USD gives up some ground ahead of ECB.
• Given the greater focus on the FOMC, today’s US ISM data could be as significant for the USD as the ECB.
• Lack of UK MPC rate hike today will leave GBP slightly vulnerable.
• SARB policy outcome and Turkish CPI also feature.

Market Outlook

EUR-USD has given up the firmer tone seen yesterday, in part because of a lack of interest ahead of forthcoming central bank meetings and also due to some anticipation perhaps that all of the possible hawkishness from today’s ECB meeting has already been discounted. A 25bp rate hike is a done deal and it is unusual on occasions of tightening for the ECB to stoke up rate hike speculation any further (see below for preview). Overall, it is next week’s FOMC meeting rather than the ECB situation that is currently the main source of market uncertainty and in this regard today’s US non-manufacturing ISM data may prove more important to the USD than the ECB.

EUR-USD has been pushing the higher end of the current trading range during this week, although it looks likely staying fairly well capped at 1.2860, while support is at 1.2720 and 1.2660. A move below 1.2720 would be a sign that the recent upmove (since July 19) has lost momentum.

Eurozone service sector PMIs were lower, especially in Germany were the World Cup effect was most noticeable. The German index fell back to 56.1 in July after rising in June to 61.0 from 56.7 in May. The numbers merely relate to the gross m/m changes that will have happened during the period in question, rather than any trend change in sector activity.

GBP had been gaining some support over the past couple of days ahead of today’s MPC outcome, but it has eased back a little this morning. While a rate hike is not generally expected, there has been some speculation about such a move. Unchanged policy seems the most likely outcome (see below for preview) and if this is the case EUR-GBP should move back up towards 0.6850. However, where it eventually settles may also depend upon the EUR’s reaction to the ECB press conference.

Day Ahead
UK – the MPC announce their latest policy outcome today and there has been some speculation about a rate hike at this meeting, with most UK data having been on the strong side over the past couple of weeks. Also, it is an Inflation Report month and in recent years August has been a popular time for UK rate movements. The last time policy was changed in the UK was the 25bp rate cut seen last August and the previous move before that was a 25bp hike in August 2004.

However, while one could advance an argument in favour of reversing last August’s 25bp cut, on the basis that retail spending has stabilised, the MPC is unlikely to feel any great sense of urgency about doing this. First of all it is not clear whether recent retail and manufacturing strength will continue (World Cup spending unwind and possible softening in overseas demand). Second, for the time being CPI strength is being driven by utility prices (negative for consumer spending) rather than core categories and unless that translates into higher wage inflation the MPC are likely to remain fairly relaxed about inflation prospects. Developments in financial markets and in the US also argue in favour of caution.

If rates are left on hold there will be no statement (as is customary) and the market will be left to wait until next week’s Inflation Report to gain any insights into the thought processes currently at work.

Eurozone – the ECB meeting is the main focal point and a 25bp rate hike seems like a done deal after the signals sent at the previous press conference – the two key elements being a) the use of the words 'strong vigilance' and b) the announcement that the ECB would physically meet (with press conference) on August 3 rather than the telephone based conference call previously planned. Key today will be what is said at the press conference, where the market will be looking to see whether Trichet attempts to downplay speculation about future moves. This will be the second rate hike in two months and the market will want to know whether this now means that rates will be raised every two months i.e. in Oct and Dec (our own view) rather than every three, as has been the case previously.

On such occasions Trichet does not tend to give too much away, not least because as spokesman for such a large group, he cannot have full confidence in portraying a consensus view on actual rate tactics that far into the future. This has in the past come across a little dovishly. On this occasion, he will most probably fend off such questions by reiterating that all options are open to them. In terms of the observations that are likely to be made on key variables such as money lending and CPI, they should be supportive about the prospect of future rate hikes, but it will be interesting to see how much weight he attaches to signs of softer conditions abroad and the Jan 1 3% hike in German VAT.

US – the non-manufacturing ISM survey will be watched for any further evidence (or otherwise) of growth moderation. Last month, the non-manufacturing ISM slipped to 57.0 from 60.3 in May and it will be interesting to see whether this has been sustained. The last time the index dipped below 60, to 56.8 in January, it was immediately reversed.

Turkey – CPI is due and while a strong number would create expectations of further rate hikes, it would not provide any great favours for local asset markets and to this extent it would be negative for the TRY. The reverse applies in the case of a weak number. Support on USD-TRY is at 1.48 ahead of 1.45, while 1.5150-1.5200 is resistance. An ‘as expected number’ will leave investors waiting for next week’s FOMC meeting and what emerges out of that in terms of global investor sentiment.

South Africa – the SARB announce their latest rate decision today and a 50bp hike is generally expected given the recent heightening in inflation expectations (higher CPI, weaker ZAR). The outcome will need to be unusual to affect the ZAR, where the general tone in global markets will remain the dominant factor in the short-term.

Data/event EDT Consensus*

GB MPC rate announcement 07.00 4.5%
EU ECB meeting outcome 07.45, press conf 08.30 3.0%
US Initial claims (w/e Jul 29) 08.30 308k
US Continuing claims (w/e Jul 22) 08.30 2475k last
ZA SARB rate announcement 09.00 8.0%
NZ ANZ commodity prices (Jul) m/m 09.00 -0.9% last
TR CPI (Jul) y/y 09.30 +11.2%
TR PPI (Jul) y/y 09.30 +14.7%
US Factory orders (Jun) m/m 10.00 +1.8%
US ISM non-manu (Jul) 10.00 56.8
AU RBA Monetary Policy Statement 21.30

Latest data Actual Consensus*
CH CPI (Jul) y/y +1.4% +1.6%
GB HBOS house prices (Jul) m/m +0.2% -1.2% last
IT PMI services (Jul) 58.6 60.3
FR PMI services (Jul) 61.0 61.3
DE PMI services (Jul) 56.1 60.1
EU PMI services (Jul) 57.9 60.1
GB PMI services (Jul) 57.9 58.5
EU Retail sales (Jun) m/m +0.5% +0.8%
* 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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