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Wednesday May 16, 2007 - 11:14:50 GMT
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Forex Research - Mellon FX Daily - U.S. Edition

Mellon FX Daily 06:40 EDT

Key Points
• The Bank of England’s Inflation Report merely validated what the market was already expecting.
• Mixed news on UK average earnings.
• Mortgage applications, housing starts, building permits and industrial production feature in the US.

Market Outlook

GBP came under some minor pressure following the Bank of England’s quarterly Inflation Report. The BoE said that medium term inflation risks are still on the upside, while they expect CPI to be at the 2% target over the two year horizon, assuming that interest rates follow the path implied by financial markets. This assumption sees rates at 5.7% in Q3, with 5.6% in Q3 08 and 5.5% in Q1 09. Inflation was shown to overshoot the target if interest rates remain at 5.5%, so the BoE is to some extent validating the expectations of a rate hike in Q3, but no more than this. There was a slight sense of anti-climax. In the labour market release, earnings ex-bonuses edged up a little, but so far the threat from wages remains limited. EUR-GBP moved above 0.6850 but still needs to break the 0.6867 mid-March highs to suggest some upside risk towards 0.6920-60. However, major GBP weakness is unlikely, as we are not currently in a situation where rate hike prospects are significantly fading.

EUR-USD has been capped by 1.3610 so far. A pullback through 1.3550 would be needed to leave the USD back on a firmer footing. The 1.3627 May 7 high should offer resistance now, ahead of the 1.3680 late April highs. It will be interesting to see if today’s US housing data reflects the recent trend of stabilisation (see below). The NAHB index (out yesterday) fell to a 15-yr low in May, with the weakness due to a tightening in lending rules related to the sub-prime fallout and the risk is that this could weigh on housing starts and permits going forward.

The JPY remained soft, with EUR-JPY pushing to new highs again. Upside risk remains in place while above 163.30-50 and key over the remainder of this week will be the tone of tonight’s GDP data and the state of global markets and investor risk in general. USD-JPY needs to break 120.50-60, while the AUDJPY continues to flirt with 100.50.

In Australia, the wage cost index rose 1.0% in Q1, below the 1.3% increase the market had been expecting. Growth in hourly pay rates ticked up to 4.1% y/y, from 4.0% in Q4, but held well shy of the 4.5% ‘danger’ level. The booming mining sector reports wages running above 6.0%, but private sector overall wage growth was just 3.9%. The numbers will be something of a relief for the RBA given that all the other data, except for CPI, has been on the strong side, but a tightening bias will remain in place. The AUD31.5bn of tax cuts promised in last week's 2007/08 Budget helped to boost the consumer sentiment index by 7.5% to 123.9, the highest since the survey began in 1975.

Day Ahead
US – housing starts have stabilised over the past couple of months after the sharp drop seen in January, but much more strength than this will be required to suggest a bottom. Building permits do appear to have stopped falling, which is one encouraging sign, but both the main home sales series (not due until the following week) have been showing weakness. The weekly data on mortgage applications is due today. Applications related to ‘house purchases’ (rather than ‘refinancing’) are currently at their highest level since early January. Caution is advised when looking at this data series, as mini-trends can often be reversed (e.g. the strength in mortgage applications in Dec and Jan quickly evaporated), so any market optimism will only build slowly and will depend upon such improvements being sustained over the next couple of weeks.

The industrial production data for April is also due, a rebound by 0.3% m/m is forecast, after a decline of 0.2% in March. Utility use should have pulled back to more normal levels, mining activity rose and the manufacturing side should also have picked up.

Data/event EDT Consensus*

US Mortgage apps – purchases w/w 07.00 +2.6% last
CA Net portfolio balance (Mar) 08.30 -C$1.3bn last
US Housing starts (Apr) 08.30 1480k
US Building permits (Apr) 08.30 1526k
US Ind prod (Apr) m/m 09.15 +0.3%
US Capacity utilisation (Apr) 09.15 81.5%
JP GDP (Q1 1st est) q/q 19.50 +0.7%
AU Average wages (Q1) q/q 21.30 +0.7% last
NZ Cullen presents 2007/08 Budget 22.00
JP BoJ policy announcement unch

Latest data Actual Consensus*
AU Consumer sentiment (May) +7.5% -0.2% last
AU Wage cost index (Q1) q/q +1.0% +1.3%
CN Ind prod (Apr) y/y +17.4% +17.5%
JP Ind prod (Mar, final) m/m -0.3% -0.6%
JP Consumer confidence (Apr) 47.4 47.2 last
GB Claimant count (Apr) -15.7k -5.3k
GB ILO unemp 3m ave (Mar) m/m +13k +21k last
GB LFS employm’t 3m ave (Mar) m/m -55k -47k last
GB Average earnings (Mar) 3m y/y +4.5% +4.8%
GB Earnings ex-bonuses (Mar) 3m y/y +3.7% +3.6%
EU CPI (Apr) y/y +1.9% +1.8%
EU CPI ex-energy/fresh food (Apr) y/y +1.9% +1.9%
* 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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