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Thursday January 11, 2007 - 11:50:26 GMT
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Forex: Mellon FX Daily - U.S. Edition

Key Points
• The JPY has weakened further helped by political comments suggesting caution on interest rates.
• USD remains firm, but EUR-USD is retaining some support ahead of today’s ECB meeting.
• Trichet is likely to be hawkish, but this may not be enough to prevent further EUR-USD downside.
• Tomorrow’s US retail sales data will also be important for the USD.
• Australian employment data supports RBA rate hike expectations.
• UK MPC meeting also features today – Japanese bank lending, LDP’s Nakagawa speech and UK NIESR GDP due tonight.

Market Outlook

The USD remains strong but one factor supporting EUR-USD at the present time is the hope of a hawkish presentation from Trichet at today’s ECB meeting press conference. Such a presentation does seem likely (see below for preview), although while this may offer some initial relief for EUR-USD, corrective pressure looks like being all-powerful in the short-term and a move towards 1.2800 is favoured. Tomorrow’s US retail sales data (and the risk of a sharp pullback to November strength) is more of a risk to USD strength and EUR-USD downside. The tone of that data will be a key factor in determining how things finish this week.

The JPY was soft in Asia and weakened significantly in Europe. EUR-JPY moved above 155.35 (high from Tuesday and the 38.2% retracement of the move from 158.05 to 153.68) and 155.86 (50% Fib level). 156.50 (series of highs from 2nd half of Dec) is the next resistance level and this may hold for now if EUR-USD does slip again. USD-JPY meanwhile has moved above 120.00, leaving near-term risk up to 121.00-40.

Vice-finance minister Fujii said he wanted the BoJ to support the economy via monetary policy. Economics minister Ota said that the BoJ’s key role was to pave the way out of deflation and that “we’re at a crucial stage for seeing whether the economy can break free from deflation”. Former economics minister and senior member of the previous Koizumi cabinet, Takenaka, said that a BoJ rate hike was currently inappropriate, while Ito, a member of the government’s economic panel aired the same sentiments. However, despite these cautionary comments the mNikkei newswire ran a story suggesting that senior BoJ officials still held the belief that the recovery would spread from the corporate to the consumer sector (citing the slight improvements seen in CPI and consumer spending data released late December). Still, even this story noted that officials had still to gauge the strength of consumer spending in the year-end shopping season. LDP policy chief Nakagawa speaks tonight and he has previously been quite critical of the BoJ’s eagerness to hike rates.

There are many doubts about the Japanese economic landscape, which argue against any near-term BoJ rate hike. However, the issue remains a slightly open one. As mentioned earlier this week, the main problem for the JPY is that even if they do raise rates this would be seen as the last one until Q3 at the earliest and would do little to change the JPY’s low yield status. Medium-term prospects continue to favour broad JPY weakening.

Australian employment data was again stronger than expected, supporting the case for a further RBA rate rise in February. Total employment was up 44.6k, while the full-time component was up 17.7k after the 63.5k rise the previous month. The unemployment rate remained at a 30-yr low of 4.6%. This kind of labour market performance is likely to convince the RBA that inflation pressure is alive and well and in need of a further policy response. Even a soft Q4 CPI number (due Jan 25) may not be enough to offset such concerns about future inflation. On the face of it the data is supportive for the AUD, which has bounced back against the JPY and steadied a little against the USD overnight. Appetite for high-yielders will remain in check a little given the recent general loss of risk appetite, although this should be rebuilt fairly soon and such a development would benefit the AUD, especially against the JPY. However, its performance against the USD in the very short-term is also complicated by the risk of further USD strength against the majors.

UK manufacturing output data was slightly stronger than expected, helping EUR-GBP to revisit the key support area from 0.6680-90 (low of 0.66835 this morning). However, we would not look for much EUR-GBP downside from here, this support area having held on several occasions in recent months.

Day Ahead
UK – the MPC meeting is likely to be a non-event, if as seems likely, rates are left unchanged as this will mean no statement. NIESR GDP (for the 3mths ending Dec) is due tonight and will be watched to see if there is any deviation from the +0.7% showings recorded in each of the previous four quarters (in both NIESR and official estimates of GDP). Last month, the NIESR GDP measure was up 0.6% for the three-months ending November.

Eurozone – the ECB are likely to leave rates unchanged and the main focus will be on the language used by Trichet at the press conference. It is the ‘vigilance’ word that will be the key focal point at this meeting. There is a feeling in the market that at some point over coming months Trichet will try and move away from the automatic nature of policy seen over the past year or so i.e. using the words ‘vigilance’ or ‘strong vigilance’ at press conferences prior to meetings when rate hikes are planned. However, the ECB may feel this could be awkward and unnecessary until they are reasonably confident that a stopping point in rates has been reached and the language used at the last meeting suggests that this is not the case just yet. Unless he vigorously attempts to suggest that the past rules on the use of the word vigilance are now defunct, the use of the word or otherwise will drive expectations about the outcome of the February meeting. Our own feeling is that the ECB will go ahead and raise rates in both February and April and that a further move to 4.25% will be seen in either June or September.

Japan – money data is due this evening and bank lending has been somewhat disappointing over the past 6 months or so. Lending stabilised in 2005 after several years of declines mainly due to the resolution of the bad loan problem (when a bad loan was eliminated this had meant a fall in lending). However, while prospects were looking good early in 2006 this has not proceeded as previously thought and lending stagnated for much of last year (see chart). It is another factor suggesting that rates are not exactly fuelling monetary expansion in Japan.

Data/event EDT Consensus*

GB MPC rate announcement 07.00 unch
EU ECB meeting outcome 07.45, press conf 08.30 unch
US Fed’s Geithner on global econ & US 08.00
US Initial claims (w/e Jan 6) 08.30 325k
US Continuing claims (w/e Dec 30) 08.30 2446k last
US Federal budget (Dec) 14.00 $21.7bn
NZ Building permits (Nov) m/m 16.45 -1.9% last
JP M2 plus CDs (Dec) y/y 18.50 +0.8%
JP Bank lending (Dec) y/y 18.50 +1.2%
GB NIESR GDP (3mths to Dec) q/q 19.01 +0.6% last
JP LDP’s Nakagawa spks 22.15

Latest data Actual Consensus*
AU Employment (Dec) +44.6k +15k
AU Unemployment rate (Dec) 4.6% 4.7%
SE CPI (Dec) y/y +1.6% +1.7%
SE CPI UND1X (Dec) y/y +1.2% +1.3%
SE AMS Unemp rate (Dec, nsa) 4.4% 4.2%
GB Ind prod (Nov) m/m +0.5% +0.3%
GB Manu output (Nov) m/m +0.3% +0.3%
* 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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