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Wednesday August 9, 2006 - 13:50:30 GMT
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Forex: Mellon FX Daily - U.S. Edition

Key Points
• The Fed held rates at 5.25% as expected, citing moderating growth due to the cooling housing market, previous hikes and high oil prices…
• But with a nod to inflation pressures, keeping the door open for another hike if needed.
• BoE Inflation Report suggests possibility of further hikes in the short term but a greater degree of uncertainty than in May.
• Canadian housing starts and New Zealand unemployment due later today.

Market Outlook

The EUR-USD is rebounding, giving back some of the losses seen in the wake of the FOMC announcement. The $1.2900 barrier is back in view on the topside as the market reassesses the implications of the FOMC statement. Overall though, the market still looks mired in a broad range and the $1.29-$1.30 region is likely to prove tough to clear on the topside. The $1.2765 Asia session low is holding, with last week’s $1.2720 low marking additional support below that.

The FOMC kept rates on hold at 5.25% as expected, noting that economic growth has moderated “partly reflecting a gradual cooling of the housing market and the lagged effects of increases in interest rates and energy prices”. There was one dissenter (Lacker) who voted for one more rate hike - not too surprising as there is often dissent at turning points, but it is the first time since last September (when Olson voted to leave rates unchanged after Hurricane Katrina). The FOMC were careful to keep the door open for further tightening if needed, remarking that “Readings on core inflation have been elevated in recent months and the high levels of resource utilization and of prices of energy and other commodities have the potential to sustain inflation pressures.” The emphasis was on the run of the data from here, suggesting the Fed is going with the soft landing view. There was just enough strong rhetoric to underpin the USD and to weigh on equities and emerging markets in the short term. One note of caution for inflation watchers will have been sounded by the turn lower in Q2 productivity (1.1%, down from 4.3% seen in Q1) and the pickup in Q2 unit labour costs (4.2%, from 2.5%).

The GBP-USD pushed up to 1.91 in early European trading but is fading from there, well shy of the 1.9150 Fed high. The Inflation Report was a little less hawkish than the market had feared, mainly due to the sheer degree of uncertainty surrounding the short term outlook for inflation - but it did lift both inflation and growth forecasts. For today, the GBP could drift lower. Supports are noted at 1.9000 and 1.8800. The 1.9150 area is clearly key on top though. If the market can muster enough momentum to clear that, then a drive towards 1.9325, for 1.9550 would be the risk.

The BoE said it expects inflation to rise to around 2.7% at the end of 2006, before receding to the 2% target in two years - through Governor King accepted that there is more than a 50% chance that inflation could breach 3% short term. It noted that there is particular impact from the pass-through of announced rises in domestic energy prices and the impact of higher university tuition fees on CPI in the short term. The latter is an especial source of uncertainty, given that the ONS has not yet made a decision as to how to deal with the higher fees in the CPI calculations itself. The BoE said it had accounted for this by assuming a 0.25% impact on CPI by the end of the year. Annual economic growth was also seen “slightly stronger” peaking above 3% in the second half of 2006, before slowing to around 2.5% at the end of 2008

USD-JPY popped up to Y115.75 in Asian session trading but has been capped by the much stronger than expected domestic data, drifting back towards Y115, with potential to Y114.60 intraday. Core private sector machinery orders rose 8.5% in June, confirming strong capital spending, versus expectations of a decline of 0.4%. However, this is probably not enough to alter forecasts for Q2 GDP (due on Friday). The Cabinet Office forecast that core orders will show a rise of 4.9% in Q3.

AUD-USD pulled back from the 0.7565 area overnight on the stronger than expected housing finance data, with 0.7630 under pressure here, with risk of a pullback to the top of the recent range at 0.7680. The number of housing loans rose to a record 63,623 in June, up 1.3% on the month and 16% y/y, suggesting that consumers took the May rate hike in their stride and this will do nothing to deter expectations of another hike.

Sweden – the employment data showed a nudge up to 5.2% in July, from 5.1% in June, largely in line with expectations. The EUR/SEK declined further and remains on course for a test of the 9.1325 July low.

Norway – unemployment rate fell in the three months to June to 3.5%, its lowest level since July 2001, down from 3.7% in May. Retail sales volumes fell 1.1% in June, after a rise of 3.7% in May, in line with forecasts. These figures should not have a big impact, with the market still likely to be looking for rate hikes, commencing with a 25bp hike on August 16 to 3%.

Day Ahead
Canada – housing starts for July are expected to ease to 225k, down from 232k in June, as rising prices and (marginally) higher mortgage rates ease demand.

New Zealand– Q2 unemployment is due.

Data/event EDT Consensus*

CA Housing starts (Jul) 08.15 225k
NZ Unemployment rate (Q2) 18.45 3.9%

Latest data Actual Consensus*
AU Housing finance (Jun) m/m +1.3% +0.5%
JP Machinery orders core (Jun) m/m +8.5% -0.4%
SE Unemployment rate (Jul) 5.2% 5.3%
NO Retail sales (Jun) m/m -1.1% -1.2%
NO Unemployment rate (May) 3.5% 3.6%
GB Global trade balance (Jun) -£6.46bn -£6.2bn
GB Non-EU trade balance (Jun) -£3.15bn -£3.5bn
GB BoE Inflation Report
* 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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