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Tuesday August 8, 2006 - 12:38:38 GMT
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Forex: Mellon FX Daily - U.S. Edition

Key Points
• FOMC decision is key, unchanged rates seems most likely and it will be difficult for the Fed not to sound dovish…
• Should weigh on the USD, but EUR-USD could still struggle at $1.30.
• Canadian building permits also due today.

Market Outlook

The EUR-USD held pullbacks to $1.28 in early London trading, ahead of today’s FOMC announcement and seems to be drifting higher again. The full preview of the FOMC meeting is outlined below but it is worth noting that if, as the market expects, the Fed holds rates steady, it will be difficult not to come across as dovish in order to justify why they are not hiking rates. Given the market’s tendency to look ahead, the risk is that the market then begins to worry about a hard landing, which would have knock-on implications for equity and emerging markets. A “no change” decision would leave the USD on a softer footing, with the key barrier for EUR gains at the $1.2950/1.30 zone, unless the Fed goes out of their way to suggest that this is not a peak in rates and that they may need to hike again later. Similarly a rate hike could undermine the USD if the accompanying statement seems to suggest that that was the last one for a while. A drive back to the $1.3665 December 2004 highs will be dependent on whether the market can muster enough energy to breach $1.30 convincingly.

There was little impact on the EUR-USD from data showing that German and Italian output came in softer than expected. German production fell 0.4%, versus expectations of a 0.3% rise, after a 1.5% increase in May. However, this still leaves industrial output up a healthy 1.6% in Q2 (from 0.3% in Q1). Italian industrial output came in weaker than expected at 0.1% in June, which suggests that production in Q2 was up only 0.1% (down from 1.2% in Q1). That reinforces potential that Italian Q2 GDP data, due for release on Friday, will show a slowdown from the 0.6% reading seen in Q1.

UK – the BRC said that July like-for-like retail sales rose 3.4% y/y, up from 2.3 percent growth in June, as hot weather boosted demand for food and drink. However, the number was flattered by the basis effect as sales fell 1.9% in July 2005 due to the bomb attacks in London. There was little impact on prices rose by 7.71% in Q2 on the yeGBP-USD which is consolidating around 1.9050 ahead of the Fed decision. Earlier, the Land Registry survey showed average UK house ar, up from the 5.1% rise reported in Q1. Sales volumes rose 23.76% in Q2 y/y.

Day Ahead
US – the FOMC meeting is the major feature and after recent data developments an unchanged rate decision seems the most likely outcome. If this is the case, the Fed will probably advance a number of reasons supporting the decision i.e. signs of growth moderation, inflation expectations under control, effects of past tightening etc, which will come across as dovish. However, they are also likely to point out that such factors will be closely monitored and that further rate hikes may be carried out if they see fit. Likewise, if they now surprise and actually hike rates, they are likely to signal that this is enough for now, leaving the market with the comfort that rates will now be on hold for a while, pending further developments in the data. Clearly, the first of these two outcomes will be best for emerging markets and global investor sentiment and the worst for the USD, although the residual risk of some further tightening may keep a slight check on the way sentiment develops in these markets. A rate hike would now be a surprise after recent data releases and at least initially would prompt a sharp reversal in recent market movements. However, the sting may be pulled slightly if there are soothing words about future meetings.

Data of note today include Q2 productivity and unit labour costs. There is likely to be some sensitivity to unit labour costs, which are forecast to rise to 3.5%, up from 1.6% in Q1.

Canada – The June building permits data is due, with the market looking for a pullback of 2.3% after a surge of 6.9% in May, when permits hit a new record.

Data/event EDT Consensus*

US Chain store sls (w/e Aug 5) w/w 07.45 +0.9% last
US Productivity (Q2, prel) saar 08.30 +0.9%
US Unit lab costs (Q2, prel) saar 08.30 +3.6%
CA Building permits (Jun) m/m 08.30 -2.3%
US Redbook sls (w/e Aug 5) m/m 08.55 -2.4% last
US FOMC meeting outcome 14.15 5.25%
US ABC consumer conf (w/e Aug 6) 17.00 -10 last

Latest data Actual Consensus*
GB NIESR GDP (3 mths to Jul) q/q +0.8% +0.6% last
GB Land registry house prices (Q2) y/y +7.71% +5.1% last
JP M2 plus CDs (Jul) y/y +0.5% +1.3%
JP Bank lending (Jul) y/y +2.0% +1.9%
DE Trade balance (Jun) €13.3bn €13.1bn
DE Current account (Jun) €10.1bn €8.1bn
DE Exports (Jun) m/m +1.5% +1.0%
IT Ind prod (Jun) m/m +0.1% +0.5%
DE Ind prod (Jun) m/m -0.4% +0.3%
GB BRC retail survey (Jul) y/y +3.4% +2.3% last
* 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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