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Friday August 4, 2006 - 10:54:58 GMT
Mellon Bank Foreign Exchange -

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Mellon FX Daily - European Edition

08:05 BST
Key Points
• EUR-USD holds firm amidst lack of ECB dovishness and weaker US data.
• GBP rally extension may require further encouragement for next week’s Inflation Report.
• RBA statement reflects recent official messages.
• Canadian/US employment reports feature today. Market Outlook

Market Outlook

At yesterday’s ECB press conference Trichet made no real effort to downplay the rate hike expectations already in market and specifically the likelihood of them hiking rates in both October and December. 25bp rate hikes in both October and December leaving the refi rate at 3.5% at year-end is also our own view. However, beyond that the situation is cloudier. German tax changes and a possible slowdown in the US economy both argue in favour caution going into the New Year, so 3.5% may be it. For the time being, the prospect of two more rate rises will offer support for the EUR, but the central factor dictating the price action over the coming week will be sentiment about FOMC policy. Yesterday’s weaker than expected ISM survey was significant in this regard and today’s employment report will also exert an influence (see below for preview). On the basis of current evidence, there is an increasing chance of the FOMC leaving rates unchanged next week and this would support some modest strength in EURUSD.

In the UK, the 25bp rate hike was something of a surprise and it would appear that the recent strength in GDP numbers was the tipping point. This along with the possibility of some profit margin rebuilding and higher wage growth has influenced official thinking on how quickly CPI will revert to target. It seems to be a case of them acting pre-emptively and not taking any chances rather than responding to a significant deterioration in the inflation outlook. Thus far the evidence of wage inflation has been largely absent. Key now for GBP will be whether next week’s Inflation Report and the MPC minutes the week after support the idea that further hikes are possible Without this support GBP may well ease back again. 0.6725-50 should be solid support on EUR-GBP, while cable will depend upon the USD in general.

The RBA’s quarterly statement on monetary policy did not offer anything new for the market. It upgraded its GDP and core CPI forecasts, but expressed confidence that inflation would remain around 3% (2.75% previously). Much will depend upon the forthcoming data, but if recent strength persists the way is open for some further tightening to ensure that targets are hit. The AUD edged higher on the news (from 0.7610 to 0.7625) but has since drifted back. The AUD outlook still looks favourable overall, but liquidation pressure remains a constraint after the recent rally. Corrective pressure could extend to 0.7550-70 short-term.

Day Ahead
Canada – the labour market report is unlikely to freshly disturb BoC policy expectations, with the BoC having firmly made the case in favour of unchanged rates for the time being. Employment has become volatile over the past couple of months (-4.6k in June after +96.7k in May) so it will be interesting to see what happens next, the market still being a little uncertain about the underlying trend.

US – the employment report is likely to continue painting a picture of moderate employment growth and if this is the case it would offer further support in favour of a rate pause. Something above the 225k-250k area will be required to get the market more worried about the possibility of a rate hike next week, but even an outcome in this area would not directly undermine the broader growth moderation hypothesis, with other data suggesting a slowing in economic activity compared to earlier this year. Also, in the absence of some chunky upward back revisions on payrolls, any payroll strength today could be seen as a one off compared to recent weaker data. Earnings data will also be watched, with last month’s y/y rate on hourly earnings rising to its highest level since the middle of 2001. However, Bernanke has pre-empted this to some degree by noting that wage growth should accelerate in the short-term but that this will not necessarily pose a threat to prices.

Data/event EDT Consensus*

DE Manu orders (Jun) m/m 11.00 +1.3%
CA Employment (Jul) 12.00 +23.5k
CA Unemployment rate (Jul) 12.00 6.1%
US Non-farm payrolls (Jul) 13.30 +142k
US Unemployment rate (Jul) 13.30 4.6%
US Average workweek (Jul) 13.30 33.9
US Hourly earnings (Jul) m/m 13.30 +0.3%
US Fed’s Stern on banking 14.45
CA PMI (Jul, nsa) 15.00 53.0
* 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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