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Tuesday November 14, 2006 - 11:46:36 GMT
Mellon Bank Foreign Exchange -

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Forex: Mellon FX Daily - U.S. Edition

Key Points
• Japanese GDP surprises on the upside.
• Nature of GDP breakdown fully highlights current dilemma facing the BoJ.
• Data complicates short-term picture for the JPY – EUR-JPY price action will provide key signals.
• US retail sales and PPI will be key for USD sentiment today.
• Eurozone data slightly disappointing, but ECB
expectations unaffected. • UK CPI weaker than expected.

Market Outlook

Japanese GDP came out stronger than expected, defying the indications provided by other pieces of data. Q3 was +0.5% q/q while Q2 was revised up to +0.4% from +0.2% initially. Consumption was down 0.7% q/q, but this was entirely offset (in terms of the contribution to total q/q growth) by a sharp 2.9% q/q rise in non-residential capex. Net exports contributed 0.4% due to strength in exports.

The implications for monetary policy are unclear as the breakdown of the data is almost a microcosm of the dilemmas currently facing the BoJ. The BoJ has made it clear in recent months that they are concerned about ultra-low interest rates artificially inflating business investment (causing excess capacity) and today’s data will lend support to these concerns. The 2.9% q/q rise in non-residential business investment follows rises of 3.5% q/q in Q2 and 3.7% q/q in Q1. On the terms the BoJ have been arguing, this alone leaves an outside chance of a rate hike over the next couple of months. However, the weakness in consumer spending is clear and with some core CPI measures still below zero, the BoJ will face a difficult task selling any tightening to the general public, let alone the government. Some stabilisation in consumer spending and/or core CPI may be required before the BoJ feels confident in hiking rates with the support of the government and the public. However, today’s data has not fulfilled its potential of completely ruling out the prospect of short-term tightening and this may offer some element of short-term support for the JPY, even though the medium-term outlook for relative interest rates remains negative for the JPY against most other currencies.

Latest IMM positioning data was also released yesterday and showed net spec JPY shorts rising to 63,512 contracts as of last Tuesday from 59,600 the previous week. Given that the upside break in EUR-JPY happened on Thursday this net short position has probably become larger since then, so it remains a potential constraint on JPY weakness if the news flow turns against the trade. It is not clear whether GDP is good enough to fall into that category, but it will raise some doubts about EURJPY upside, which had looked very convincing after Thursday’s break. The data prompted JPY strength in Asia – with EUR-JPY a time falling back below the previous high and recent breakout point at 150.75 (reaching a low of 150.58). However, the JPY has weakened in Europe and an important indicator of immediate direction will come from EUR-JPY and which level it breaks first on a closing basis – 150.75 or last week’s high around 151.50.

The softer USD-JPY helped EUR-USD to edge higher in Asia but EUR-USD has been unable to progress any further in Europe. Some minor disappointments in the Eurozone data have helped to cap EUR-USD, but essentially the market is eyeing today’s key US releases – retail sales, PPI. The tone of this week’s US data will be highly significant for overall USD sentiment (see below for preview).

Eurozone Q3 GDP came in 0.1% softer than expected at +0.5% q/q, while the ZEW surveys revealed a similar pattern to recent months – current conditions very strong, expectations very weak. German ZEW current conditions rose to an all-time of 53.0 from 42.9 – well above the previous high of 45.8 seen in September 2000. Expectations fell to a new 13-yr low of -28.5. This adds weight to argument that the weakness of expectations may have become directly related to the strength of current conditions. On the expectations question respondents are asked whether they are optimistic or pessimistic about the economic situation in six months time and there is always a chance that such responses are made with reference to how things are presently, which are very good. This negative ‘base effect’ is probably being compounded by fears about the impact of the German VAT hike.

UK CPI was unchanged at +2.4% y/y, while core CPI was also unchanged at +1.4%. The outcomes were weaker than expected and doubly surprising perhaps after the stronger than expected data seen in the previous two months. There was a real mixed bag of influences, with education and food exerting upside pressure on the CPI y/y rate and fuels and furniture/household goods exerting downward pressure. The latter will have been comforting to the MPC as the ‘furniture, household equipment and maintenance’ category had been showing some strength in recent months, raising fears that the so-called China effect was starting to lapse. GBP weakened on the data, although at this point the report does not significantly threaten the February rate hike currently priced in by the market. Tomorrow’s average earnings and Inflation Report will be significant in that regard.

Day Ahead
US – Retail sales, PPI and business inventories and sales are due today. Core PPI has been volatile in recent months, with +0.6%, -0.4% and -0.3% being the m/m showings for Sep, Aug and Jul respectively. The market may be less inclined to respond to this data in sustainable fashion due to this volatility, especially with CPI still to come on Thursday, although any unusual outcomes will have an initial impact. The tone of the retail sales data could be more important. A quick glance at retail sales ex-autos in recent months (-0.5% Sep, +0.2% Aug) would appear to suggest that spending has been subdued, although this is related to lower spending at gas stations as a result of lower fuel prices. If one excludes gas station spending as well as autos, sales rose 0.8% last month after rises of 0.4% and 0.6% in Aug and Jul. From this perspective spending has been quite strong. Business sales have also been exhibiting some firmness in recent months.

Switzerland – SNB’s Roth is due to give a speech entitled “International currency order or disorder”. If he makes any reference to the CHF it is likely to be similar to recent utterances – namely that CHF weakness poses an upside risk to the inflation outlook. EUR-CHF has been reasonably firm this morning, but there could be some slippage later on. Risk to 1.5900-10.

Data/event EDT Consensus*

US Chain store sls (w/e Nov 11) w/w 07.45 +1.0%
US Retail sales (Oct) m/m 08.30 -0.4%
US Retail sales ex-autos (Oct) m/m 08.30 -0.2%
US Retail sales ex-autos/gas (Oct) 08.30 +0.8% last
US PPI (Oct) m/m 08.30 -0.6%
US PPI core (Oct) m/m 08.30 +0.1%
US Business inventories (Sep) m/m 08.30 +0.5%
US Business sales (Sep) m/m 08.30 +0.8% last
US Redbook sls (w/e Nov 11) m/m 08.55 +0.3%
CH SNB’s Roth spks on FX markets 12.15
US Fed’s Poole speaks 12.30
NZ Retail sales (Sep) m/m 16.45 -0.1%
US ABC consumer conf (w/e Nov 12) 17.00 -3 last
AU Consumer sentiment (Nov) 18.30 +3.9% last
JP Tertiary index (Sep) m/m 18.50 -0.6%
AU Wage cost index (Q3) q/q 19.30 +1.1%
AU House prices (Q3) q/q 19.30 +1.0%
CN Ind prod (Oct) y/y 21.00 +16%

Latest data Actual Consensus*
US Federal budget (Oct) -$49.3bn -$49bn
NZ PPI output (Q3) q/q +0.7% +2.7% last
JP GDP (Q3 prel) q/q +0.5% +0.2%
DE GDP (Q3 prel) q/q +0.6% +0.7%
ES GDP (Q3 prel) q/q +0.9% +0.9%
NL GDP (Q3 prel) q/q +0.6% +0.7%
IT GDP (Q3 prel) q/q +0.3% +0.5%
GB CPI (Oct) y/y +2.4% +2.6%
GB CPI core (Oct) y/y +1.4% +1.6%
GB RPIX (Oct) y/y +3.2% +3.3%
GB RPI (Oct) y/y +3.7% +3.8%
EU GDP (Q3 prel) q/q +0.5% +0.6%
DE ZEW expectations (Nov) -28.5 -24.5
EU ZEW expectations (Nov) -11.0 -11.0
* 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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