Euro and Yen Frozen In Place

Trading was so quiet in Asian and European trade today that for hours range was literally equal to spread, as both euro and the yen stayed frozen in place with neither buyers nor sellers able to budge price by more than a few points either way.

For currency traders desperate for volatility tonight's trading was the equivalent of a root canal without Novocain. In short this was a market that only Central bankers could love. Yet central bankers figure prominently on today's calendar and may in fact provide some much needed volatility later in the day.

In Japan earlier today Deputy Governor Toshiro Muto repeated BOJ' s mantra that the central bank did not have any predetermined, specific time for the next policy adjustment, but the undertone of his comments clearly suggested that Japanese monetary authorities are moving towards further tightening. As our colleague Kathy Lien reported yesterday, Toyota's 25% increase in sales compared to the decidedly mixed results of the Big 3 clearly demonstrates the competitive power of lower yen.

Note that most Japanese corporates projected 110 USD/JPY rate as their hedge level in 2006 budgets. With the pair trading full 8 big figures above that number the benefits to the export driven Japanese industrial sector have been enormous. As real rates in Japan continue to remain negative, BOJ's ultra low interest rate policy may become unsustainable both economically and most importantly politically, especially if US experiences a slowdown in job growth in the latest NFP reports due to this Friday.

Meanwhile both UK and EU have interest rate announcements on tap with BOE scheduled for 11:00 GMT and ECB for 11:45 GMT. The BOE is expected to stay pat at 4.75%, although many market analysts forecast a further 25bp hike in November in light of the fact that UK housing market - one the key drivers of BOE monetary policy - has not only stabilized but shown signs of sustained growth in recent months.

ECB for its part is expected to raise rates by 25bp to 3.25% narrowing the interest rate differential between the euro and the greenback to 200bp. ECB President Jean Paul Trichet will most likely reaffirm his call for vigilance but at the same time will once again stress that the bank will not make any ex-ante policies. In plain language the ECB should hike rates another 25bp before year end, but Mr. Trichet will make no promises that it will do so.

With recent EZ inflation data receding from the 2.5% peak reached in June, EZ monetary officials have less economic ammunition to make an uber-hawkish case for further tightening. However, if Mr. Trichet focuses on problems of excess liquidity in EZ rather than just price levels, traders may bid the EUR/USD higher on the assumption that the ECB may raise rates beyond the current market expectations of 3.5% by year end.