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Thursday October 5, 2006 - 11:50:50 GMT
Mellon Bank Foreign Exchange -

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Forex: Mellon FX Daily - U.S. Edition

Key Points
• JPY steadier ahead of today’s ECB meeting and possible comments from Trichet about the JPY.
• Market has dovish take on Fed comments, although the steady policy message was essentially unchanged.
• MPC meeting also features today – unchanged rates should see EUR-GBP upside.

Market Outlook

The JPY has slightly stabilised with the market a little apprehensive ahead of today’s ECB meeting. MoF official Watanabe said that the MoF were not watching particular currency levels, but were looking at whether moves are volatile or reflect fundamentals. Again, this is not a major protest and the comment about not looking at particular levels may actually spur confidence about a possible sustained move in EUR-JPY above 150.

Earlier in the day, the BoJ’s Muto generally reaffirmed their approach to gradual policy tightening. Muto was generally noncommittal on the likely course of policy, but the fact that there was no real softening of the BoJ’s prior stance modestly supports the notion of a possible rate hike before year-end. The ECB meeting will be significant for Trichet’s attitude to the JPY, which he will no doubt be questioned on at the press conference (see below for preview). In the absence of a strong protest the JPY is likely to weaken afresh and this could see the recent highs on EUR-JPY (around 150.75) being threatened.

Comments from Bernanke and others confirmed current thinking on Fed policy. The central point was their expectation of a moderation in price pressures going forward and this led to a moderately dovish reaction in the money market. However, while they acknowledged the downside risk from the housing market, they also noted that current readings on core inflation were not consistent with their idea of price stability and that there was a still a risk that price moderation would not happen. In this regard, they see the upside risk to inflation as a greater issue than the downside risk to growth.

EUR-USD remains deadly quiet. The minimal reaction seen to yesterday’s much weaker than expected non-manufacturing ISM highlights the lack of investor interest in this rate at the current time. However, as we have been noting, recent oil price declines may be providing some protection to the current US data weakness, as weaker oil should support economic activity over coming months. It will take something unusual out of today’s ECB meeting or tomorrow’s US employment report to shake things up in the short-term.

GBP has retained good support going into today’s MPC meeting, although the likelihood is that they do nothing and the disappearance of event risk would suggest some EUR-GBP upside (see below for MPC preview).

Day Ahead
UK – the market has been somewhat concerned about this week’s MPC meeting (outcome due today) after having suffered the surprise of a rate hike in August. There is a sense that if November is a done deal, then why not hike now - why wait? There is clearly some logic to this argument, although not all of the data has been hawkish since the last meeting. Average earnings growth has softened for example and the ONS has significantly revised down the nominal GDP number for Q2. A rate hike today cannot be ruled out but in the circumstances most members may prefer to wait until next month, when they have the opportunity to revisit their GDP and inflation forecasts as part of the Inflation Report preparation. The MPC seems to feel more comfortable in changing policy after having completed the due diligence of re-examining their forecasts. In other words, why hike rates now when they can do so more confidently in a month’s time.

Eurozone – a 25bp rate hike seems assured at today’s ECB meeting and the main focus will be on Trichet’s press conference to see a) what he says about CPI after the recent fall, b) whether he attempts to give any signals on rates beyond the hike already discounted for December and c) whether he mentions the JPY. He is likely to express some satisfaction with the CPI weakness, but will also point out that lower oil prices help to support economic activity and that the German VAT hike will boost CPI in January. On rate expectations, there would seem to be no real need to upset market expectations at the current time. The ECB is probably quite happy with the rate profile currently discounted inasmuch as it provides them with much room for manoeuvre.

It is the subject of the JPY that is perhaps the most interesting. As a rule, Trichet very rarely comments about exchange rates, so when he does say something he is clearly trying to send a message (e.g. the ‘brutal’ comment about EUR-USD two years ago). However, a major protest seems unlikely today and the most that can probably be expected is a reiteration of the comments he made at the recent G7 meeting i.e. G7 were agreed that the JPY would eventually reflect Japan’s economic recovery.

Data/event EDT Consensus*

GB MPC rate announcement 07.00 4.75%
EU ECB meeting outcome 07.45, press conf 08.30 3.25%
CA Building permits (Aug) m/m 08.30 +1.0%
US Initial claims (w/e Sep 30) 08.30 314k
US Continuing claims (w/e Sep 23) 08.30 2444k last
CA PMI (Sep, nsa) 10.00 60.0
US Fed’s Plosser on econ and policy 12.30
* 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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