Bob's Currency Focus - 12:15 GMT

EUR/USD
The euro has hit a high for the month on Tuesday, reaching 1.5673, with the dollar retreating broadly across the board. Rocketing oil prices are having an adverse impact on the dollar over the past week and it will probably take a sustained reversal in energy prices to provoke a meaningful rally for the greenback. German producer prices came in twice as high as expected for April and with costs spiraling everywhere at present, the inflation threat is fast becoming the dominant market influence. Of course the trigger for the current rally in oil was the Fed’s monetary easing policy which began last September and while this policy has helped to ease the credit crisis, it has also resulted in a significant increase in the cost of living for everyone, thanks to the frenzy-like rally experienced in commodity prices. The impact on consumer discretionary spending should not be underestimated, even if equity markets have failed to notice the threat to date. Consumer and business sentiment indicators should be watched very closely over the coming weeks as these will give more of a current market insight than actual growth and output numbers. Germany’s important ZEW survey, released Tuesday, pointed to further decline in confidence on the part of investors in May. The result was a surprise as a marginal improvement was expected. This did not stop the euro rally and the single currency is currently trading at more than a cent up on the day. There is no chance of a rate cut from the ECB in the immediate future and with inflation further on the rise, it is a rate hike that is beginning to look the more likely. There is the possibility of a push to 1.5720 for EUR/USD, before a sharp pullback to below 1.55. The US calendar is relatively bare this week with Producer Prices today and Friday’s Existing Home Sales the highlights. There are more significant indicators out of the euro area this week – the German Ifo survey is released Wednesday and the preliminary readings for the May PMIs are out on Thursday. The euro is overvalued, even if dollar confidence is low and any downside surprises in the Ifo and PMI numbers could trigger major rallies to the downside for EUR/USD.

GBP/USD
Sterling has benefited handsomely from a dollar retreat and cable rose to 1.9665 earlier today, up almost 2 cents from last night’s close. There was no data out of the UK and sterling’s surprising rally is thanks to an influx of funds into the high yielding currencies and a fall in confidence for the dollar. The pound is unchanged against the euro, down against the franc and up against the yen. The fundamentals have not changed and the fact remains the UK economy is slowing and economic data is deteriorating, so sterling remains exposed to sharp sell-offs, on any meaningful rallies, particularly against the dollar. Attention tomorrow will switch to the Bank of England’s minutes from their May meeting, when they are released at 08:30 GMT and with inflation riding high, a hawkish set of minutes seems likely, possibly ruling out a rate cut in June. Inflation is an issue for all Central Banks at the moment, but the high inflation threat is likely to offer nothing more than temporary protection to sterling, given the eroding growth fundamentals in the UK. Cable should be sold down on any rallies close to 1.9770 and a return to 1.9400 is a high probability over the course of this week. There is little value in buying the euro against sterling at present prices, although a break above 80 pence could trigger a momentum-driven rise to 81 pence. Sterling is exposed on the yen and Swiss crosses, if stock markets extend their declines through to Wednesday.

JPY
The yen has made modest gains against the dollar Tuesday, but has lost against every other major currency as the Bank of Japan stands pat on interest rates. The Central Bank also today warned of the downside risks to the economy, thereby ruling out the prospect of a near-term rate hike and fuelling a new wave of carry trades. The Aussie dollar has risen to Y100 today despite a sharp decline in equities in both Asia and Europe, while the euro has risen to Y163. While risk appetite remains high the yen is going to struggle to make any headway and it will be prone to immediate sell-offs on any significant rallies. The dollar is currently hemmed into a 103 to 105.50 price range, but the smart money is buying the pair on dips. The euro is over-extended against the yen and while there is a chance of a rally to Y165, there is the risk of a return to Y158, especially if the decline in stocks continues as a theme this week. AUD/JPY should be watched closely as this is the standard bearer for the carry trade and a rally that extends to above Y100 could spark a further wave of carry buying, particularly for the high-yielders.

CAD
The loonie has been on a remarkable rally over the past week, gaining substantially against every other major currency, with the exception of the Aussie dollar. On Tuesday USD/CAD hit a low of 0.9874 and is currently trading just above this price level. Economic data has proven to be of only secondary importance to commodity prices when determining price direction for the loonie and the Canadian currency is the benefactor behind a major speculative drive in the past week. There are some important data releases out this week, with consumer price inflation and retail sales numbers out on Wednesday and Thursday respectively. Even a poor set of data numbers may not derail the loonie as it has shown itself to be pretty much immune to adverse economic data throughout this year. Any prick in the commodity bubble would be much more damaging for the loonie’s immediate fortunes and a reversal in oil prices could signal a sharp retreat in the Canadian currency. A dip below 0.9850 is possible today but a sharp return back above the parity line for USD/CAD is most probably in the coming days. The euro looks to offer good value against the loonie on any dips to or below 1.54, with a probable return to 1.56 later in the week.

Bob B - May 20