The US dollar strengthened this morning in response to the G7 statement on the weekend, which acknowledged that there had at times been sharp volatility in the major currencies. EURUSD traded down to a low of around 1.5670 from a NY close of 1.5810, while USDJPY traded to a high of 101.97 from an NY close of 100.98.

In the official statement, the G7 said that: "We reaffirm our shared interest in a strong and stable international financial system. Since our last meeting, there have been at times sharp fluctuations in major currencies, and we are concerned about their possible implications for economic and financial stability." This was in contrast to the February statement, which said: "We reaffirm our shared interest in a strong and stable international financial system. Since our last meeting, there have been at times sharp fluctuations in major currencies, and we are concerned about their possible implications for economic and financial stability." The fact that the US dollar itself if not mentioned specifically is a reminder that the Americans believe that a weak US dollar is appropriate given the US economic situation. As such, the statement reflects a compromise between the interests of the Europeans and the interests of the Americans.

Economic developments on Friday played to the fears of slowing growth and elevated inflation. The Uni of Michigan consumer sentiment index for April fell to 63.2, down from 69.5 in March, and disappointing expectations of 69.0. Also, long-term inflation expectations as captured by the survey rose to 3.1% in April, up from 2.9% in March. Finally, import prices rose by 2.8% in March, following a 0.2% m/m gain in February.

The markets have probably over-reacted to the G7 statement, since the statement only referred to volatility rather than the level of the dollar. We judge that intervention remains unlikely, unless there is a reoccurrence of the extreme volatility witnessed in recent weeks. This week, we would watch comments by Fed officials this week in any sign of increased concern about the limits to cutting rates in the context of rising inflation expectations, which would be dollar-supportive. Earnings in the US are also being announced which may be important to risk appetite. We would look for dollar upside this week, particularly against the commodity currencies in lieu of this morning's soft NZ retail sales. We continue to target EURUSD at 1.55 over 1 month and 1.47 over 3 months.

Newly appointed BoJ Governor Shirakawa said following the G7 meeting that the credit crunch had not too much impact on the real economy just yet. Meanwhile, Finance Minister Nukaga declined to comment on the changes made to G7 statement, saying that it speaks for itself. Shirakawa's comments suggest that he won't be in too much of a hurry to cut rates. It will be a light data week in Japan. Consumer confidence, due Tuesday, will have likely improved over the prior month. However, investor risk appetite will remain the main driver of yen, and hence corporate earnings in the US and Fed official comments will be perhaps more important. We think risk aversion will remain structurally elevated and target USDJPY at 100 over 3 months.

The GBP has continued to weaken on concerns over the spill-over effects of deteriorating credit conditions. Following Thursday's BoE decision our economists have revised their BoE policy rate forecast such that they now expect four more rate cuts this year, resulting in the bank rate ending the year at 4%. Data this week should keep GBP on the backfoot, with RICS house price balance and DCLG house prices due today and Tuesday respectively. Also, CPI data on Tuesday will likely show the inflation rate remaining unchanged, although above the BoE's 2% target. We still believe that sterling weakness is overdone, but EURGBP is unlikely to come off as long as the ECB holds a hawkish line.

NZ retail sales this morning for February were released and unexpectedly fell by 0.7% m/m, versus market expectations of a rise of +0.3%. Our NZ economist does not believe that today's data will by itself cause the RBNZ to adjust its stance, but it does add to the weight of evidence that domestic demand has slowed sharply. The soft data coincided with a similar decline in Australian retail sales for February, released earlier this month. The data will likely keep AUDNZD elevated, but with the market already quite long the cross, we prefer downside in NZDUSD.