US Dollar Strengthens but CPI Data not Expected to Supportive (page 1 of 2)

DailyFX Fundamentals 02-20-07

By Kathy Lien, Chief Strategist of DailyFX.com

US Dollar- Even though the US dollar is stronger ahead of tomorrow's consumer price report, this does not mean that the market is looking for a strong inflation number. Instead, the lack of US data this week aside from the CPI number is helping the dollar recover some of its losses from the prior week. The recently reported drop in producer prices suggests that we could see a similar decline in consumer prices, especially as inflation growth slows globally. However before we even get to the US CPI release there are a number of potentially market moving events over the next few hours. This includes a testimony by RBA Governor Stevens, the Bank of Japan interest rate decision (which we elaborate on in the Yen commentary), and the minutes from the most recent Bank of England monetary policy meeting. After the CPI report, we have the release of the minutes from the Federal Reserve's monetary policy meeting in January. This will most likely prove to be a nonevent since the minutes should contain a similar the message as the one that Bernanke delivered at his semi-testimony on the economy and monetary policy, which is that they have adopted a wait and see approach. Recent weakness in US data and concerns about sub-prime mortgages could force the Federal Reserve to hold back on future rate hikes to make sure that the health of the banking sector is not in jeopardy and to avoid forcing even more mortgage borrowers into default by increasing the rate of adjustable rate mortgages.

Euro - After last Thursday's power move, the Euro has had a very difficult time extending its rally. Today's weakness comes on the back of softer producer price figures from Germany and less hawkish comments from European officials. Over the past 2 weeks, we have heard nothing but very hawkish comments from Eurozone officials. Today however that hawkishness appears to be abating on the back of comments from Spanish politician Solbes and EU's Alumnia. Solbes said this morning that interest rates will not go much higher while Alumnia said that inflation pressures are not excessive. Neither of these people are members of the ECB, but the shift is still worth noting. The sole ECB member who spoke today was Mersch who continued to suggest that the central bank will raise rates in March. Over in Switzerland, the inflation and trade data were a wash as producer prices fell short of expectations while the trade surplus beat expectations.

British Pound - The British pound is stronger today thanks to firm money supply and public finance data. M4 money supply grew by a healthy 13 percent in the month of January while net monthly lending hit a fresh record high. This surprising strength is a testament to the difficulty of handicapping the Bank of England's monetary policy. Economic data is frequently mixed with a batch of weak data followed by a batch of good. Perhaps this is why the BoE has to be so dynamic and have proven to flip their monetary policies as necessitated by the direction of economy. This is the main reason why tomorrow's release of the MPC minutes from the monetary policy meeting held earlier this month is so important. After delivering a surprise rate hike in January, recent data still leaves the door open for the central bank to raise rates again this year. Whether the British pound has what it takes to break above today's high is dependent upon how the members of the committee voted earlier this month. If the decision to leave rates unchanged was unanimous, then the odds for a rate hike in March will be very low.