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Wednesday March 21, 2007 - 11:04:14 GMT
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Forex Research - Mellon FX Daily - U.S. Edition

Mellon FX Daily 06:35 EDT

Key Points
• FOMC statement keenly awaited – a major change of tone seems unlikely.
• The reaction of the equity market & the JPY as well as the ability of EUR-USD to stay above 1.3260 will be key to short-term FX market direction.
• GBP and AUD prospects will be influenced by how such matters pan out.
• UK MPC minutes more dovish than expected.
• UK Budget features today amidst growing talk of a “Big Budget” for taxation.
• Canadian retail sales also due today, Japanese trade data and MoF business survey due tonight.

Market Outlook

The USD was hurt for a while yesterday by a report about China no longer accumulating FX reserves, although such a statement merely seems to be a reference to the fact that a portion of their reserves (and probably more in the future) will be handed over to a separate agency for management. To this extent it is information that has already been revealed.

USD-JPY has stabilised since the pullback seen yesterday, while EUR-USD has traded quietly through the night (Japan is on holiday today). The market is essentially waiting for today’s FOMC statement before taking a further view and key will be whether EUR-USD can hold on to last week’s break through 1.3260 if, as we believe, (see below for preview) the statement fails to inject any fresh dovishness into the policy debate.

Another key factor will be the reaction in the equity market, as this will dictate sentiment towards the JPY, which in turn will have implications for the recent GBP recovery. Both the EURUSD and the JPY reaction will also be significant for whether the AUD can establish a foothold above 0.80, which it is currently threatening to do. How these markets close this week will be revealing for short-term direction.

GBP gave up some of yesterday’s gains earlier this morning after MPC minutes revealed an 8-1 vote in favour of unchanged rates, with the dissenter being Blanchflower who voted for a cut! The rest decided to leave rates unchanged, while acknowledging that the overall risks to inflation in the mediumterm remained to the upside. However, they did state that the short-term outlook for CPI was softer compared to the February Inflation Report (owing to weaker January CPI and news of big cuts in utility prices) and also noted, significantly, that “the initial recorded outturns for recent wage settlements and relatively subdued inflation expectations led the Committee to judge that the upside risk to inflation from wage growth might have started to diminish.” This comment was made before the release of the latest average earnings data, which was weaker than expected. Overall, this would appear to rule out a hike in April and reduces the risk of a May rise, although the market is likely to continue discounting a May hike for now. The development is negative for GBP, although cable held on to short-term support at 1.9555 and bounced back well, perhaps on the growing belief that today’s Budget (previewed below) will reveal something substantial on the tax system. However, it seems unlikely that this will be a major positive for GBP and today’s minutes could easily resurface as a negative later today.

Day Ahead
UK – the UK Budget has become the subject of increasing speculation in recent days, centring on the possibility of a 1% cut in the corporate tax rate and a full reform (or at least a formal review) of the personal and business taxation system. Today’s FT cites Treasury sources as saying that this will be a ‘Big Budget’ and will include tax reforms. The corporate tax cut would be a response to the trend seen in recent years where European governments have been easing their corporate tax burdens and eroding the advantage previously enjoyed by the UK. The second would tackle head on one of the criticisms frequently advanced by the opposition Conservative party about the UK tax system being too complex. On both counts it would, politically, be a convenient way for Brown to depart as Chancellor and to take over as PM.

If one or both of these things does emerge it would be positive for the UK economy and GBP from a longer-term perspective. However, whether there is an enduring impact on GBP in the short-term is less clear. Today’s minutes have already advanced a negative slant to the domestic interest rate backdrop and GBP will also be driven by other matters after the FOMC statement e.g. EUR-USD, equity markets and the JPY. Note also that any changes in tax today will almost certainly be revenue neutral and should not carry implications for monetary policy.

Canada – retail sales (due today) bounced back in December after weakness in prior months, although the market is looking for a softer number this time around. The CAD is in the ascendancy after yesterday’s surprisingly strong core CPI number, coming as it did against the backdrop of some hefty long USD-CAD positioning. The break below 1.1680 yesterday was significant and 1.1700 needs to be won back to avert the risk of further losses. A solid FOMC statement may provide some uplift for USD-CAD later today, although downside risk remains in place and next supports are at 1.1590 and 1.1565.

US – the FOMC meet and it will be interesting to see how much they acknowledge the weakening seen in some of the data and if they do, whether this leads to any adjustments to the phrase “inflation pressures seem likely to moderate over time” used in the previous statement. However, the slowing in the data seen so far is probably no more than the FOMC will have expected and is consistent with the mid-cycle/inventory adjustment pause that is typically seen after the initial emergence from sub-par growth. While the focus on the housing market has switched to the trouble facing sub-prime lenders, the actual housing data is also proceeding fairly close to FOMC expectations. The subprime issue may well get a mention today alongside a reminder of the importance of the housing market, although such references are more likely to be soothing than alarmist. With most core inflation indicators still elevated, the FOMC will not be comfortable in signalling an all clear on the outlook for inflation. Overall, this statement may not differ too much from the one advanced at the last meeting.

Japan – the MoF business survey is due tonight and will be seen as a possible taster for the April 2 Tankan. Trade data will provide an update on export performance, which has remained strong in recent months (see chart).

Data/event EDT Consensus*

JP Market Holiday
US Mortgage apps – purchases w/w 07.00 +2.2% last
GB UK Budget 08.30
CA Retail sales (Jan) m/m 08.30 -0.2%
CA Retail sales ex-autos (Jan) m/m 08.30 +0.2%
CA Leading indicator (Feb) m/m 08.30 +0.4%
US FOMC rate announcement 14.15 unch
JP MoF manu survey (Q1) 19.50 7.1 last
JP MoF all-industry survey (Q1) 19.50 6.4 last
JP Trade balance (Feb, sa) 19.50 ¥700bn

Latest data Actual Consensus*
US ABC consumer conf (w/e Mar 18) -5 +2 last
IT Consumer confidence (Mar) 112.6 111.2
GB MPC minutes (Mar 7-8 meet) 8 unch, 1 cut 7 unch, 2 hike
*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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