US Dollar Strengthens as Inflation Data Surprises to the Upside (page 2 of 2)

The committee voted 7 to 2 to leave interest rates unchanged at 5.25 percent. Once again, Besley and Sentence who are typically categorized as hawks voted in favor of an interest rate hike. However the other members of the monetary policy committee voted against one because they felt concerned about delivering rate hikes that were too closely spaced together. They wanted to give the economy time to absorb the latest rate hikes and also wanted to avoid over tightening. The take away message is that the BoE has adopted a wait and see approach like the Fed and will not be raising interest rates in March or April. Near term inflation is expected to drop and the BoE will want to wait to see a pickup before driving rates higher again. The CBI industrial trends survey was the only piece of UK data released today. The index surged from -9 to 4 in the month of January, suggesting a recovery in manufacturing.

Japanese Yen - The Japanese Yen dropped through the floor today despite an interest rate hike from the Bank of Japan. As we suggested yesterday, regardless of how the BoJ swings, the yen may not rally on the back of the rate decision. This was how things unfolded over the last 12 hours as cautious comments from the Bank of Japan reinforced the market's belief that despite the increase, interest rates will remain low and any further rate hikes will be delivered gradually. We expect the Bank of Japan to repeat what they did back in July of 2006, which is to give the market at least 4 to 6 months to absorb the latest rate increase before tightening policy again. As an export dependent nation, Japan does not want to see a rapidly appreciating Yen and they especially do not want to trigger massive carry trade liquidation. At 0.50 percent, Japan still offers the lowest yield in the developed world, which is keeping the Yen an attractive funding currency for carry trades.

Commodity Currencies (CAD, AUD, NZD) - The Commodity Currencies are stronger across the board and they have good reason be to with gold prices up $21 an ounce to a 9 month high and oil prices back above $60 a barrel on news of refinery shutdowns. The Canadian dollar staged the strongest rally thanks to its solid retail sales figures for the month of December. Holiday spending proved to be exceptionally strong which is another piece of evidence that the Canadian economy is improving. The recent string of positive reports has driven the Canadian dollar to a 6 week high against the US dollar. The Australian dollar is also performing well thanks to the hawkish comments from RBA Governor Stevens last night. He was optimistic about growth said that rates were more likely to rise than fall. His comments were reinforced by the stronger fourth quarter wage data and leading indicator reports released last night. For the time being, carry trade demand continues to keep both the Aussie and Kiwi bid.