EURUSD rose to a fresh high of 1.5980 in the US session, as strong Eurozone inflation was juxtaposed against more weakness in US housing starts. However, risk appetite also improved as earnings did not come in as bad as some feared and the S&P500 managed to rise by 2.3%. Oil took advantage of the weak dollar and rose to another record high of US$115.17/bbl, in turn helping the CAD be one the main beneficiaries of dollar weakness.

US economic data overnight did not provide any justification for a near-term rebound in the dollar, with housing data weak and CPI in line with expectations. Housing starts for March declined by 11.9% m/m, while building permits declined by 5.8% m/m. US CPI for March met rose by 0.3% m/m and 4.0% y/y and was in line with expectations, while core CPI rose by 2.4% y/y. Comments by Fed official Yellen, were of note but also were not clear cut for the rate outlook and the US dollar. San Francisco Fed President Yellen said that financial market turmoil had impacted households, businesses and state and local governments throughout the country. Importantly, she said that weakness in housing has not only set off a chain of events that have "rattled the financial system", but also caused spillover effects now visible in the rest of the economy. However, she did say that Fed actions to date coupled with tax stimulus should help to support the economy, and that the Fed did care about inflation.

Events overnight and yesterday were consistent with EURUSD staying elevated for now, but we don't change our view that the US dollar will strengthen from current levels. There are two legs to a reversal in the US dollar. First, we need to see the ECB start signalling a return to a neutral bias - difficult at this stage with inflation high and oil hitting record highs. Second, we need to see the Fed signal greater concern on inflation. Our near-term bias is for EURUSD to stay at elevated levels, but fall on a 1-3 month view.

Today, there are no major events for the majors in the Asia session. In the US we have jobless claims, comments from Fed's Kohn, and earnings from Bank of New York Mellen and Merrills.

HICP inflation in March were revised up to 3.6% y/y. On the monthly comparison they came in at 1.0% above consensus 0.9% m/m. High inflation continues to be a challenge for the ECB. With a slowdown in growth coming, its hands are tied to respond with high inflation rates such as these presenting a real risk those inflation expectations. We continue to believe that inflation has peaked and think that it will decline over the next 12 months as it responds to the slowdown in growth that we expect. On Tuesday, Germany's April ZEW sentiment index was reported at -40.7, far worse than a consensus forecast for -30.0 and down on March's -32.0. The current situation index held up well, coming in at 33.2 versus a consensus for 32.8 and 32.1 last month.

In comments yesterday, newly-appointed BoJ Governor Shirakawa noted that the carry trade is increasing in some markets and the BoJ will closely monitor the situation. He also said FX rates should reflect economic fundamentals, which may hint that further strength in the JPY is undesirable as the Japanese economy will face significant headwinds up ahead. We have not seen evidence so far suggesting the carry trade has been increasing. Our analysis on aggregate short-JPY positioning on the Tokyo Financial Exchange show positions have been tracking sideways since the carry rout in mid-August of last year. Although volatility has eased in recent weeks, the move has largely been equity-led and the upcoming earnings season could provide plenty of catalysts for a return in volatility-as shown by the selloff last Friday on the back of disappointing results from a key US blue-chip. Investors in general are maintaining a defensive stance for now and with risk appetite structurally weaker over the past months, we expect the carry trade to remain muted in the medium term. We continue to target USDJPY at 98 in 1m and 100 in 3m.

UK CPI inflation, at 2.5% y/y, they came in below expectations (cons. 2.6%). RPI inflation moderated to 3.8% vs. 3.9% expected. Lower than expected inflation gives the MPC room to cut interest rates by more than its own forecasts. We expect the next rate cut in June, supporting our view for cable to retreat further. The RIC house price balance for March came in a t -78.5, weaker than market expectations of -67. The house price balance result is the lowest since the series began in January 1978, indicating further deterioration in housing market sentiment in the UK. A RICS spokesman noted that the slowdown is directly attributable to a lack of available finance, which has hit demand. However, until new supply increases dramatically, a significant crash remains unlikely. In other news, the Telegraph reported this morning that a Chinese Sovereign Wealth fund has built up a 1% stake in a major UK oil producer. We have recently expressed concern that the BoE's troubling tolerance for sterling weakness may result in a sharp reduction in official buying of GBP by reserve managers, but UK assets may be looking attractive at current levels and offer opportunities for countries seeking sustained diversification in the face of dollar weakness.