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Friday August 25, 2006 - 11:09:24 GMT
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Forex: Mellon FX Daily - U.S. Edition

Key Points
• Weaker than expected CPI hits BoJ tightening expectations and the JPY.
• Revisions mean that government’s alternative measure of core CPI has yet to move away from deflation.
• Further JPY downside testing likely today, even though government is putting a brave face on it.
• Bernanke features today.

Market Outlook

The JPY is softer following the downward revisions to the CPI data released last night. The impact of the revision was much greater than expected, with the y/y rate on Nationwide CPI ex-fresh foods for June being revised down to +0.2% from +0.6% previously and +0.2% also being the outcome for July. The government’s alternative measure of core CPI, which excludes food and energy had its y/y rate for June revised down to -0.4% from +0.2% previously and the July number was put at -0.3%. This means that on the basis of the ex-food and energy measure Japan has not yet moved out of deflation, with negative y/y numbers being recorded as far as this series goes back.

Even the main ex-fresh foods measure does not look impressive. If the new data set had been known at the time of the rate hike on July 14 the BoJ would have been taking that action after a run of ex-fresh food y/y rates from January to May of -0.1%, 0.0%, +0.1%, -0.1% and 0.0%. It seems highly unlikely that rates would have been raised against such a backdrop.

The +0.2% numbers seen in June and July will allow some to make the argument that an uptrend in the y/y rate is still in place, but it is a very modest one and the impression that is left is not great in terms of Japan’s current ability to generate any meaningful inflation.

The authorities are probably in a state of shock. Six months ago the government would have used this information in their public arguments against the need for premature BoJ rate hikes. However, the data is so bad that it seems like they will avoid making too much of it, on the basis that to do so would raise the risk of promoting deflation rather than inflation expectations, which would be highly counterproductive. PM candidate Abe,finance minister Tanigaki and economics minister Yosano all said today that an end to deflation remains in sight and were keen to play down the data. They stated that the +0.2% showings for June and July were evidence that it was heading in the right direction, but there was no mention of the weakness in their previously preferred core measure, which excludes energy as well as food.

For the BoJ the data will be seen as very frustrating. They were already mindful of the meagre inflation Japan was creating, but this was still enough to allow them to concentrate on other reasons for moving away from very low interest rates (i.e. a normalisation in the money market and the need to avoid rash corporate spending decisions triggered by abnormally low interest rates). Their room for manoeuvre has been limited even further by this news and in spite of the natural desire for rate normalisation, pursuing rate hikes in this type of CPI environment will be very difficult. There is a fair chance that rates will be now be left on hold for the rest of this year, unless key CPI y/y rates strengthen afresh in the next few months. However, we should perhaps wait and see what the BoJ says before rushing to firm conclusions.

The development is a clear negative for the JPY as it will play on concerns already in place about its low yielding status. After all the excitement this year about the move away from zero rates the sense of anti-climax is becoming ever stronger. A test of 117.50-118.00 looks likely on USD-JPY in the short-term, while 150 is also likely to be threatened on EUR-JPY. How the BoJ respond to the CPI data will be significant in determining whether such levels break. Closes above these key levels (118 and 150) will be required to convince the market about the likelihood of more JPY weakness in the short-term.

EUR-USD has also been constrained this morning, which is perhaps related to the fact that EUR-JPY is seen as hemmed in by 150, meaning that USD-JPY strength has weighed on EURUSD. However, 1.2700 should provide decent support. Despite the developments in the data this week – soft US home sales, strong durable orders, the mixed messages from the ZEW and IFO surveys, EUR-USD looks firmly set in its current range.

Day Ahead
US – Bernanke is due to speak about Global Economic Integration at the annual Jackson Hole conference and it is not clear whether he will touch upon issues that are sensitive to monetary policy. In fact even if he were to do so, it seems unlikely that he will alter market perceptions about policy risks going forward, with the latest FOMC statement implying that all options remain open.


Data/event EDT Consensus*

DE CPI (Aug, prel) m/m n/a 0.0%
US Fed’s Bernanke spks on Global Economic Integration 10.00

Latest data Actual Consensus*
JP CPI Tokyo (Aug, core) y/y 0.0% +0.2%
JP CPI Nwide (Jul, core) y/y +0.2% +0.5%
JP CPI Nwide ex-food/energy (Jul) y/y -0.3% -0.4%R last
SE Trade balance (Jul) SEK12.2bn SEK14.5bn
SE Current account (Q2) q/q SEK41.9bn SEK58.3bn last
NO Unemployment rate (Jun) 3.2% 3.4%
GB GDP (Q2, 2nd est) q/q +0.8% +0.8%
GB BBA mort approvals (Jul, nsa) y/y +4.6% +22% 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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