Euro and Yen Weaken As Data Disappoints

Both the euro and yen fell steadily against the greenback in Asian and early European trade this morning as eco data printed slightly lower than expectations.

In Japan National CPI rose as expected by 0.3% but the Tokyo numbers were more muted jumping only 0.4% versus 0.6% forecast. The news caused further yen selling to the 118.00 figure, but the unit found some support there with USD/JPY unable to climb above 118.13.

Although price increases may have been smaller than anticipated, the fact of the matter is that Japan has now recorded four consecutive months of positive inflation data and real short interest rates in the country are now negative.

Furthermore, should this pace of price growth continue into the end of the year rates will only become more negative creating an unsustainable dynamic for the BOJ. With Prime Minister Abe now firmly ensconced in the seat of power and political transition over, Japan's monetary policy makers may finally feel free to act unhampered by political considerations which could mean the possibility of another rate hike before the year end. Monday's Tankan survey may significantly increase the chances of this scenario if it prints within or above expectations of 20.

Meanwhile in Europe the news was considerably less bullish as both German Retail Sales and Euro-zone CPI fell below expectations. Retail sales during the month of August in Germany unexpectedly stalled showing no rise at all against estimates of a 0.8% rebound from last month's upwardly revised -0.8%. Consumers had been expected to boost spending ahead of the 2007 VAT hike but stagnant wage growth and higher energy prices may have contributed to cautious attitude on the part of the German consumers.

Lower energy prices in September could help to get shoppers back into stores and improve next month's reading, but with business and investor sentiment for the future dwindling quickly and interest rates predicted to rise yet again next week to 3.25%, consumption levels could be weak in coming months raising questions about additional rate hikes beyond the 3.5% level. Furthermore, with EZ inflation now solidly below ECB's own 2% target rate as exemplified by tonight's 1.8% reading the need for further hikes becomes problematic.

Although ECB officials have repeatedly stated that they are concerned not only with inflation but with liquidity levels as well, the dour retail numbers may give them pause in considering just how much further they should tighten.