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Wednesday February 21, 2007 - 08:46:46 GMT
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Forex Research - Mellon FX Daily - European Edition

Mellon FX Daily 08:10 GMT

Key Points
• BoJ raises rates by 25bp, but signals gradual tightening.
• Soft data backdrop suggests no major re-rating of rate hike prospects.
• Negative JPY outlook remains in place.
• UK MPC minutes, Canadian retail sales and US CPI feature today.

Market Outlook

The Bank of Japan decided to take the plunge and raise rates by 25bp, reflecting their natural instincts towards rate normalisation, as well as a possible attempt to try and restore some credibility regarding their independence after the political jibes seen in recent months. With CPI set to weaken in the months ahead and the July Upper House elections moving ever closer, they may have also seen this as something of a last chance to raise rates in the first half of the year. However, the data circumstances behind the move remain questionable, as it is not clear at the present time that the strength in the corporate sector is affording any benefit to the consumer. The data over the past six months or so suggests stagnation in consumption and if the data remains soft in the coming months this would actually damage BoJ credibility. CPI is also in danger of weakening in the months ahead, with the core CPI ex-fresh foods y/y rate set to move closer to the much weaker ex-food and energy measure. LDP secretary Nakagawa made this fairly plain when he stated that the BoJ should be held responsible for the effect of these policies.

The JPY strengthened a little when the decision was announced, but this only lasted a couple of minutes, with the market quickly focussing on the BoJ assurance that further tightening would be gradual. Indeed, it is almost certainly the case that no more rate hikes will be considered until Q3 and this will leave the JPY as a low-yielding currency without any support from rate hike speculation. This backdrop would become even worse if there is any weakness in key data releases. As noted yesterday, a rate hike at today’s meeting is not enough to trigger a major re-rating of future rate hike prospects and this is what is needed to undermine the carry trade argument. For example, the Euro-yen interest rate future for Dec 07 has only risen to 0.94% from 0.91% yesterday. On this basis the immediate outlook for the JPY remains negative, although the market may be slightly wary about some residual corrective pressure, especially if the Europeans try and capitalise on the move by verbally reiterating their desire for a weaker EUR-JPY. 160-plus on EUR-JPY and 124-125 on USDJPY are feasible in the weeks ahead.

Day Ahead
UK – MPC minutes could provide some clues about when the next rate hike will be. With last week’s Inflation Report suggesting upside risk to CPI if rates are left unchanged, one could argue that there is a case for an immediate rate hike, so it will be interesting to see what sort of appetite there is for such a
move. A key issue will be why rates were left unchanged in February. One reason, which would have hawkish consequences, would be that they had already hiked and surprised the market once in January and did not want to do so for a second month running. This would suggest that a rate hike has merely been deferred for tactical reasons. More dovish would be that a sizeable majority saw reason to wait and assess incoming information further. Of course, there could be a divergence of views and members could be in either camp, in which case it will be a case of trying to gauge likely numerical advantage at forthcoming meetings. The latest CBI manufacturing survey is also released. 0.6685 and 0.6760 are the key short-term parameters on EUR-GBP.

US – CPI will be watched to see whether the recent more subdued readings on core CPI (+0.1% Oct, 0.0% Nov, +0.2% Dec) have been sustained. There is a sense that recent weakness will prove to be temporary. A few more readings of +0.1% or lower will be needed to spur speculation about a change in Fed language when describing inflation risks.

Canada – retail sales have been weak in recent months, but today’s data is for December and the strength in wholesale sales for that month suggest a risk of a strong number today. Whether this is genuine or merely the result of mild winter weather confusing the seasonal adjustment factors remains to be seen, but strong data would help the CAD.

Data/event EDT Consensus*

IT Consumer confidence (Feb) 08.30 110.8
EU Current account (Dec) 09.00 -€1.0bn
EU Balance of payments (Dec) 09.00
GB MPC minutes (Feb 7-8 meeting) 09.30
ZA CPI (Jan) y/y 09.30 +6.0%
ZA CPIX (Jan) y/y 09.30 +5.2%
GB CBI manu trends survey (Feb) 11.00
US Mortgage applications w/w 12.00 -1.0% last
US CPI (Jan) m/m 13.30 +0.1%
US CPI core (Jan) m/m 13.30 +0.2%
CA Retail sales (Dec) m/m 13.30 +1.0%
CA Retail sales ex-autos (Dec) m/m 13.30 +0.6%
US Lead indicators (Jan) m/m 15.00 +0.2%
US Fed’s Kohn on financial stability 18.00
US Fed’s Yellen on econ outlook 20.25
JP Trade balance (Jan, sa) 23.50 ¥768bn
AU AWOTE wages (Q4) q/q 00.30 +0.7% last

Latest data Actual Consensus*
US ABC consumer conf (w/e Feb 18) +1 -3 last
AU Wage cost index (Q4) q/q +1.1% +1.0%
JP BoJ rate announcement +25bp Market split
FR CPI (Jan, prel) y/y +1.2% +1.4%
* 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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