USD

The US dollar finished the week stronger against EUR and JPY, up around 0.5% w/w against both. The stronger dollar came in the aftermath of ECB President Trichet not signalling an intent to serially lift rates following the ECB rate hike on Thursday. On Friday markets were quiet with the US on holiday for Independence Day. It will be a quiet week in the US, with only pending home sales and the preliminary University of Michigan reading for July of note. We are looking for the index to dip slightly to 56.0 from 56.4 previously. Inflation and employment expectations embedded within the report will also be crucial. The Fed has softened its tone slightly on interest rates as growth indicators continue to deteriorate. However, with the ECB also displaying somewhat weaker-than-expected resolve to further its price stability agenda, the market will need space to absorb recent policy decisions in the G10 space. Further volatility in yield differentials will continue to determine the dollar's short-term prospects.

We continue to see EURUSD at around or above current levels in the short term as significant headwinds remain for the dollar and the ECB has not ruled out any possibility at this stage. The dollar's gains late have not translated into significantly weaker oil prices. At current oil prices Eurozone inflation will also continue facing upside risks. We only see EURUSD easing on a three month basis as a marked downturn in growth forces the ECB onto a more dovish track. Nevertheless, this may be delayed if any corresponding drop in demand fails to adversely affect oil prices. We are currently long a 3m EUR put (initiated June 16th) with a strike at 1.51. Today is the first of the G8 Summit in Hokkaido. Central bankers won't be attending and climate change along with food and oil prices will be on the agenda. The summit ends on July 9.

JPY

BoJ Governor Shirakawa spoke this morning and kept to a familiar script. He said that global inflationary risks were intensifying but said that Japan's economy was slowing on high energy and raw material prices. He said that Japan will likely return to moderate growth after a slowdown. The data flow is limited for the week but the G8 summit due to be held between July 7 and July 9 in Hokkaido will attract market attention. High energy and commodity prices will be in focus but with central bankers absent, though specific agreements targeted at lowering energy prices may have an effect on oil prices. In Japan itself, industrial production and core machinery orders are the key releases for the week. Output is still expected to show declines as global demand begins to soften. The trade balance is also due and the market is expecting a decline to Y500 bn.

EUR

The ECB decision last Thursday surprised markets as Trichet stuck to his comments from last week and did not hint at any interest rate hikes in upcoming meetings, nor did he commit himself to any possibility of easing as inflation rates "have continued to rise significantly". Crucially for markets, he noted that the decision "will contribute to achieving our objectives" and has "no bias". Recent data points to a clear moderation in the Eurozone economy, and although the ECB's decision was unanimous, Trichet's comments reflect the need for pragmatism as risks of policy error have risen. Despite sounding sanguine on the Eurozone economy he acknowledged that weakening domestic and external demand would impact GDP up ahead. The ECB is facing a similar conundrum to Fed in seeing room for manoeuvre in monetary policy contract sharply. However, with recent confidence surveys still pointing to rising inflation expectations and rising risks of second-round effects, the ECB may still choose to hike if necessary. Yields remain well above their levels in early June and further gains in oil prices may continue to prevent any anchoring of inflation expectations. We remain cautiously positive on the EUR in the short-term while yields stay supportive, but we expect more downside in the medium term as growth deterioration continues.

GBP

The BoE decision on Thursday will be the highlight of the week. Despite rising inflation numbers having triggered a Governor's letter to the Treasury, weak growth and ongoing deterioration in housing markets will keep the BoE on hold at 5.0%. Despite ongoing expectations of an upside move up ahead, we continue to expect the next move to be down, but not until May next year.