50 Bips or Bust For Euro

Talking Points

·          Aussie Jobs demand up 7.7% as strength continues

·          JPY Cap spending nearly double expectations

·          UK Services surprise with strength

·          Will ISM Services disprove the slowdown?

The FX market started the week with only one thought on its mind the European Central Bank will raise rates by 50 basis points rather than previously expected 25 at its monthly meeting announcement scheduled for 11:45 GMT this Thursday.  Last weeks Euro-zone economic data  which produced nothing but a green forest of better than forecast results has convinced many players that ECB will risk the potential of even greater appreciation in the EUR/USD in order to contain the rapidly expanding inflationary pressures in the 12 member region.  Last week Euro zone CPI increased to 2.5% - well above ECB self imposed target of 2% while PPI skyrocketed to 5.4% on a year over basis. In fact market expectations have been so elevated at this point, that only a 25 basis point hike will not be enough to sustain the EUR/USD rally. <?xml:namespace prefix = o ns = "urn:schemas-microsoft-com:office:office" />

Thus, the central question facing the market this week will be whether ECB officials decide that the inflationary pressures in the 12 member union have reached a point of such danger that they would risk further currency appreciation to contain the impact of rising prices.  For now at least, the usual wails of protest from EZ finance ministers have been relatively muted as the general feeling amongst the business sector is that EZ companies can absorb the higher exchange rates. However, should the pair climb much above the 1.3000 level expect the rhetoric to heat up.

In the meantime, the issues for the dollar have been completely reversed as Fridays horrid NFP results have put a lid on any expectation of further rate hike from the Fed.  Chicago Feds Moskow remained true to his hawkish self by stating that inflationary pressures remained and that Feds reputation is at stake. But Mr. Moskow is a non voting member this year and may speak freely, while the rest of the FOMC has to consider the very real possibility of tipping the <?xml:namespace prefix = st1 ns = "urn:schemas-microsoft-com:office:smarttags" />US economy into  a recession just as the country enters into the 2006 mid-term Congressional elections should they continue to tighten into a slowing economic environment. Todays ISM Non Manufacturing report may dispel some of the dollar gloom for the time being should it remain above 60, but the near term forces in FX appear to be aligned against the greenback as the EUR/USD make its way inexorably towards the 1.3000 figure.

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