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Wednesday September 6, 2006 - 11:16:39 GMT
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Forex: Mellon FX Daily - U.S. Edition

Key Points
• EUR-USD steady – JPY and GBP weaker.
• USD could be influenced by today’s non-manufacturing ISM – unusually weak last month.
• Australian Q2 GDP weaker than expected, but only because of inventories.
• US Beige Book, BoC policy outcome, Australian employment due.

Market Outlook

EUR-USD remains hemmed in by recent ranges, although the JPY has weakened this morning, taking back some of the moves seen so far this week. The latter may have a little further to go today, but some renewed JPY strength would not be surprising ahead of Friday’s BoJ announcements. The USD could be sensitive to anything unusual from today’s non-manufacturing ISM, which was unusually weak last month (see below for preview). The Beige Book is also due today.

GBP has been showing clear signs of vulnerability over the past 24 hours, with the strength of recent weeks running out of steam. The EUR-GBP break above 0.6770 this morning set it up positively in Europe and there is now some scope into the 0.6800-20 area. 1.8830-60 is support on cable.

The RBA left rates unchanged as expected, but the AUD suffered a shock from a much weaker than expected outcome on Q2 GDP (+0.3% q/q compared to a market consensus of +0.8%). However, the nature of the GDP shortfall is cause for comfort. The main reason for the outcome was a sharp drop in inventories, with the latter taking 0.8% off the headline q/q GDP number. In other words, if inventories had been neutral, GDP would have been up 1.1%. Interpreting inventories is not always straightforward; for example is the running down of inventory voluntary (i.e. sellers expect the upturn in demand to be temporary) or involuntary (i.e. they have been caught out by the strength of spending or are in still in the process of deciding whether it is permanent). Given the strength seen in most other indicators it is probably fair to assume that the weakness in inventories was largely involuntary and that some restocking should now follow. This should provide a significant boost to GDP in Q3. The AUD weakened on the news, although it has since stabilised. 0.7720 has managed to cap the AUD so far and this should hold, although the strength in many commodity prices (up sharply yesterday) should provide solid support. Labour market data is out tonight.

Day Ahead
US – the non-manufacturing ISM will be closely watched after the weakness seen last month, when the main index fell back to 54.8. The last time the non-manufacturing ISM fell below 55.0 was in September 2005 (hurricane-related) while the occasion before that was Jan-Apr 2003 (the Iraq war). Other than such exceptional circumstances, sub-55 readings are normally associated with weak economic conditions. There is a risk of a rebound in this number today but if another weak showing is seen it would reinforce sentiment about an impending economic slowdown.

The Beige Book should see a repeat of the previous edition in July, which noted a moderation in growth and only patchy evidence of inflation. The report concluded that net increases in wages and the price of goods and services remained modest. A similar conclusion looks likely on this occasion, which would support current sentiment about steady FOMC policy.

The 2nd estimate of Q2 productivity and unit labour costs is due out and labour costs are likely to remain elevated (due to the slowdown in GDP compared to Q1) but below the 1st estimate because of the recent upward revision to Q2 GDP. For the time being the market is likely to remain more relaxed about inflation risk pending further news from key core PPI, CPI and PCE price measures.

Canada – apart from a modest uptick in core CPI, most Canadian data has been soft and this should ensure that the BoC leaves rates on hold at today’s policy announcement. The BoC outlook has been based on the likelihood of strong domestic demand growth being offset by a negative drag from net exports. The latter has been borne out by recent data developments, but domestic activity has also been soft over the past couple of months. The BoC will probably allude to this in their policy statement, but may also make the point that it could be partly related to the timing of the July sales tax cut. Consumers could have suspended spending decisions in May and June ahead of the tax cut, so sales could recover in July and August (data not being available for either month just yet). Overall, the unchanged policy outlook will likely be reaffirmed.

Australia – employment data is due tonight and the market will be keen to see whether the strength of recent months has continued. Even a softer number (in isolation) would not be enough to undermine the overall trend of improvement in the labour market.

Data/event EDT Consensus*

US Productivity (Q2, 2nd est) saar 08.30 +1.6%
US Unit lab costs (Q2, 2nd est) saar 08.30 +4.0%
CA BoC policy announcement 09.00 4.25%
US ISM non-manu (Aug) 10.00 55.1
US Beige Book for Sep 20 FOMC 14.00
GB NIESR GDP (3mths to Aug) q/q 19.01 +0.8% last
AU Employment (Aug) 21.30 +10k
AU Unemployment rate (Aug) 21.30 4.8%

Latest data Actual Consensus*
US ABC consumer conf (w/e Sep 3) -15 -19 last
AU RBA rate announcement 6.0% 6.0%
AU GDP (Q2) q/q +0.3% +0.9%
GB Ind prod (Jul) m/m +0.2% +0.2%
GB Manu output (Jul) m/m +0.2% +0.2%
DE Manu orders (Jul) m/m +1.8% +1.0%
* 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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