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Thursday September 7, 2006 - 10:59:44 GMT
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Forex: Mellon FX Daily - U.S. Edition

Key Points
• JPY recovers sharply after comments about G7 meeting.
• US unit labour cost data looked ugly, but it should be treated with caution for now.
• GBP remains soft, aided in part by UK political unrest – Blair set to depart next year.
• EUR-NOK upside risk after breaking 8.1675.

Market Outlook

The JPY has been the big mover this morning, recovering sharply after comments by German deputy finance minister Mirow, who said that next week’s G7 meeting would discuss JPY weakness and the CNY. The comments should be taken seriously as deputy ministers are usually heavily involved in the pre-meetings that take place before the main event. Before the comments were made the JPY had been trading softly, with EUR-JPY just below the 149.70-150.00 resistance area. However, EUR-JPY fell sharply after the comments, with positional fragilities once again being exposed. The speed of this move suggests a fair chance of more to come during the rest of today and below Tuesday’s correction low of 148.26 would be the trigger for this (148.28 was the low this morning).

Tonight’s BoJ announcement is also reason for some element of caution, even though they are unlikely to provide any great clarity on the outlook for interest rates. They are likely to express confidence in the economy and the broader move out of deflation, while acknowledging that future policy will depend upon the data. Bank lending data is also due tonight and this has been recovering since the middle of last year.

With EUR-JPY spearheading the JPY move, this has weighed on other EUR crosses, including EUR-USD, but the latter has once again failed to make any real progress either way. EURGBP was already moving lower before the JPY announcement and as long as 0.6788 holds today there is every chance of
0.6820-30 being approached over the next 1-2 days. The biggest threat to this and perhaps EUR-USD as well would be a further sharp move lower in EUR-JPY.

Eurozone news this morning has been generally positive with German data strong and the ECB report reiterating Trichet’s comments from last week. Furthermore, ECB council member Mersch said that he was in agreement with market expectations about rate hikes in the short-term and in keeping with yesterday’s stance from Weber, also hinted that rate hikes would not necessarily end this year. He said that the ECB “will exercise the greatest vigilance, not just in the immediate future, but you should also expect that the ECB won’t have lost its imagination at the end of the year”.

GBP weakness in recent days has been primarily driven by a loss of momentum after recent gains, but the political situation is probably not helping. Whether Blair or Brown presides over the UK is unlikely to matter that much, although Brown’s record as a tax-meddler means that it should not be seen as good news. The indication to the media from Blair’s office this morning was that he would step down as PM on May 4 next year and that after a leadership contest his successor (widely expected to be Brown) would be in place by June 15. However, the details on his departure have yet to be officially confirmed.

EUR-NOK is one EUR cross that has been advancing today, following yesterday’s late European burst through the key 8.1675 level (January 2006 high). The weaker oil price seems to be affecting sentiment on the NOK, even though the vast bulk of oil earnings are recycled back into foreign asset markets. There may also be some apprehension ahead of the October 6 budget presentation. This is likely to see higher taxes and higher spending and there is some uncertainty over how far the government will further dip into oil revenues to finance higher expenditure. If yesterday’s advance through 8.1675 can be held it would leave risk of a test up towards 8.24-25, although we would not expect such gains to be sustained. 8.2220 has already been seen this morning.

The much stronger than expected US unit labour cost data was something of a shock, especially the huge upward revisions to Q1. In terms of q/q seasonally adjusted annualized rates Q2 was revised up to +4.9% from +4.2% and Q1 up to +9.0% from +2.5%, with the latter due to hourly compensation being put at +13.7% from +5.3% originally. These are big numbers – so big in fact that one has to be slightly skeptical about them. One could argue that the scale of these rises increases the risk of core inflation staying high. However, if they are ‘bonus’ related as oppose to ‘wage’ related they are more likely to be payments that companies can afford and by definition should be less of an upside pressure on end-pricing. In sum, for now it is probably best to stay focused on the main core measures of inflation for PPI, CPI and core PCE prices. The rise in the non-manufacturing ISM does not dramatically change market views on the state of economic activity as the 54.7 seen on this index for the previous month always looked unusually weak. Indeed, other components of yesterday’s ISM were soft, especially orders (52.1 being the lowest since 2002/03). The Beige Book also painted a picture of moderate growth and a general lack of worrisome pricing pressure. There is little on today’s agenda with the capacity to push EUR-USD significantly in either direction, although comments later on today (after European hours) from the Fed’s Yellen will be closely watched.

Day Ahead
UK – the MPC announce the result of their latest policy discussion and given that last month’s rate hike was largely precautionary (on the basis of what was revealed in the minutes), rates are likely to left unchanged today. The market fully expects such an outcome so impact is likely to be limited.

Data/event EDT Consensus*

GB MPC rate announcement 07.00 4.75%
US Initial claims (w/e Sep 2) 08.30 312k
US Continuing claims (w/e Aug 26) 08.30 2486k last
CA Building permits (Jul) m/m 08.30 -1.8%
CA PMI (Aug, nsa) 10.00 61.3
US Fed’s Yellen on econ & policy 14.40
JP M2 plus CDs (Aug) y/y 19.50 +0.5%
JP Bank lending (Aug) y/y 19.50 +2.1%
AU Housing finance (Jul) m/m 21.30 +0.4%
AU Trade balance (Jul) 21.30 -A$0.7bn
JP BoJ policy announcement n/a 0.25%
CH Unemployment rate (Aug, sa) 01.45 3.3%
JP BoJ monthly report 02.00
DE Trade balance (Jul) 02.00 €12.7bn
DE Current account (Jul) 02.00 €8.2bn

Latest data Actual Consensus*
GB NIESR GDP (3mths to Aug) q/q +0.8% +0.8% last
AU Employment (Aug) +23.4k +10k
AU Unemployment rate (Aug) 4.9% 4.8%
CH GDP (Q2) q/q +0.7% +0.8%
GB HBOS house prices (Aug) m/m +1.0% +0.5%
SE Ind prod (Jul) m/m +0.4% +0.5%
NO Manu output (Jul) m/m +1.0% +1.0%
DE Ind prod (Jul) m/m +1.2% +0.5%
* 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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