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Wednesday February 14, 2007 - 12:48:03 GMT
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Forex Research - Mellon FX Daily - U.S. Edition

Mellon FX Daily 07:05 EST

Key Points
• EUR-USD breaks above recent range highs in early European trading.
• Upside risk is now in place, but US obstacles need to be overcome to sustain the move.
• Tonight’s Japanese GDP will be crucial for JPY sentiment in run-up to next week’s BoJ meeting.
• UK Inflation Report offers support to GBP.
• US retail sales and Bernanke testimony feature today.

Market Outlook

EUR-USD broke beyond the recent range highs around 1.3050- 60 in early European trading, with stops being triggered above that area. There was no particular factor behind the move, although yesterday’s news items (strong Eurozone GDP, higher than expected US trade deficit) provided the platform for the development and the fact that higher levels were sustained through the Asian session was also a positive. Upside risk is now clearly in place, but the move needs to be sustained through the rest of today (i.e. a close above 1.3050-60) as there are obstacles around, most notably US retail sales and the Bernanke policy testimony. 1.31 has held so far and any intraday move above there would be a strong signal that today’s break will prove to be durable.

The JPY has taken a backseat to the moves seen over the past few hours, with the higher EUR-JPY, softer USD-JPY development merely reflecting what has happened on EURUSD. The market is now on hold ahead of tonight’s Japanese GDP number, the tone of which will determine market sentiment in the run-up to next week’s BoJ meeting (see below). The Bank of England’s latest Inflation Report forecast CPI at the 2% target in two year’s time, but only on the assumption that interest rates are raised in line with market expectations (5.6% is assumed for Q3). This in itself is slightly hawkish, although CPI is seen dipping below 2% in 2007 and in the third year of the forecast it also moves back below target, so the MPC is not exactly in a state of panic about inflation. They noted downside risks to the outlook for 2007 and upside risks thereafter. The report said that businesses appeared to be more confident about raising prices, but noted that the early picture emerging from the wage round was one of modest pay growth.
The GDP profile and risks outlined in the report were similar to those seen in November.

The tone of King’s comments in the press conference were fairly hawkish (e.g. the MPC is determined to make sure inflation remains under control; CPI at +2.7% is no cause for comfort about future trends), although such CB rhetoric should not be of any great surprise given that CPI currently remains well above target and that King will still be keen on trying to contain developments in the current wage round, which runs from Jan to Apr. It is also clear that most of the recent news on inflation (CPI and evidence on pay settlements) has been weaker than initially feared a few weeks back.

Indeed, one of those factors, an FT report about a likely wage survey from the EEF (Engineering Employers Federation) looks like turning out even weaker than first thought. The FT reported on Monday that the survey would show that few settlements had been in excess of 3.5%, although today the suggestion is that the EEF will report that more than half of the deals agreed upon in the 3-mths ending January were for 3% or less.

In sum, today’s Inflation Report is consistent with the notion of one further hike in the months ahead and next week’s MPC minutes will provide some clues about how quickly that could happen. Today’s news has helped to put GBP on a more even keel after the shock of yesterday’s CPI release and a quieter time looks likely until the MPC minutes are seen. Retail sales data is due tomorrow.

Labour data was also released this morning, with earnings slightly softer than expected and employment and unemployment numbers painting a slightly stronger than expected picture of the labour market.

USD-CAD has enjoyed better news flow in recent days (strong employment, strong exports) and this has appeared against a background of hefty long USD-CAD positioning. Risk towards 1.1600 in the short-term.

Day Ahead
US – Bernanke’s semi-annual policy testimony is the main highlight, although it seems unlikely that he will unveil anything new on policy thinking. The basic tone of his presentation is likely to be consistent with the ‘upward price risk’ message advanced in the recent FOMC statement and the fact that they are continuing to monitor the data. He will also be keen to push the view that while some uncertainty persists, the economy is developing in a satisfactory manner. Retail sales data is released today and looks like staying fairly solid, while business sales and inventories are also due. Business sales rose 0.5% last month (in November) after falling 0.2% and 2.3% in October and September respectively, so it will be interesting to see whether this recovery has continued.

New Zealand – retail sales is due this evening and will feed directly into RBNZ thinking on policy. The strength of the consumer sector has been a key factor behind RBNZ warnings about the risk of a rate hike in coming months.

Japan – Q4 GDP is out this evening and should show a rebound in growth from the weak 0.2% q/q reading seen in Q3. This will merely reflect volatility in consumer spending rather than any solid trend of expansion and is unlikely to clear current uncertainties (especially about consumer spending and CPI) sufficiently to allow the BoJ to raise rates.

Data/event EDT Consensus*

US Retail sales (Jan) m/m 08.30 +0.3%
US Retail sales ex-autos (Jan) m/m 08.30 +0.3%
US Bernanke semi-annual policy testimony 10.00
US Business inventories (Dec) m/m 10.00 +0.3%
US Business sales (Dec) m/m 10.00 +0.5% last
NZ Retail sales (Dec) m/m 16.45 -0.2% last
JP GDP (Q4 1st est) q/q 18.50 +0.9%
GB RICS house prices (Jan) 19.01 +34%
AU House price index (Q4) q/q 19.30 +1.5%

Latest data Actual Consensus*
US ABC consumer conf (w/e Feb 11) -3 -1 last
AU Consumer sentiment (Feb) m/m +1.7% +2.2%R last
JP Current account (Dec, sa) ¥1.87trn ¥2.02trn
CN CPI (Jan) y/y +2.2% +2.6%
JP Ind prod (Dec, final) m/m +0.9% +0.7%
GB Claimant count (Jan) -13.5 -5k
GB ILO unemp 3m ave (Dec) m/m -23k -29k last
GB LFS employ’nt 3m ave (Dec) m/m +51k +14k last
GB Average earnings (Dec) 3m y/y +4.0% +4.1%
GB Earnings ex-bonuses (Dec) 3m y/y +3.7% +3.7%
US Mortgage applications w/w -1.0% -0.8% last
* 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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