The US dollar weakened overnight as improving risk appetite weighed on the low-yielding currencies, driving both EURJPY and EURUSD higher. Stock markets rose, with the S&P500 up by 1.1%, while the Vix index finally fell below the 18 mark, trading to a low of 16.92. Fed Chicago President Evans overnight described monetary policy as accommodative and said that the US economy should show an improvement by early 2009. However, the main focus this week on the Fed front is commentary by Fed Chairman Bernanke who speaks later today and again on Thursday, with the Thursday appearance followed by a Q&A session. We would note that there have been no significant economic developments since the last FOMC statement, but there is a possibility that Bernanke's commentary could reflect the tone of recent commentary by the non-voters, which would be dollar-supportive. We remain EURUSD bears, expecting data in coming weeks to confirm deterioration in European growth, domestic demand and credit growth - all of which should lessen inflationary pressure. With Europe following the US, the relative monetary policy stance between Europe and the US will give further support to the dollar. We maintain our 3-month target for EURUSD at 1.47, with the pair having overshot our 1-month target of 1.55. Ahead today, retail sales for April is due at 1230 GMT, while Fed Chairman Bernanke speaks on "Federal Reserve Liquidity Measures" at 1220 GMT.

The RICS house price balance for April was released this morning and fell sharply to -95.1 versus -79.4 in March, and is at its lowest levels since 1978. The data follows on from yesterday's April PPI inflation, which rose to multi-year highs, and highlights the BoE's dilemma of managing high inflation in the context of sharply slowing growth. Today's CPI data for April, will provide further insights on this front. Deteriorating activity should tame inflationary pressures, and we continue to look for an additional 100bp of easing by year-end. We think GBP is weakening in trend terms and target cable at 1.93 three months.

In a speech yesterday, new BoJ Governor Masaaki Shirakawa said the central bank needed to pay close attention to the risks facing the economy and said interest rate cuts would be appropriate if the economy were hurt by rising energy prices. The comments may come as a disappointment to investors expecting upside potential in interest rates in light of last month's inflation print, but the BoJ has firmly placed growth at the top of its priorities. The governor warned that many uncertainties, such as the situation in overseas economies, market volatility and commodity prices merit such a stance. Meanwhile, Japan's Economy Minister Ota said Japan's government could declare that deflation had ended if wages show clear signs of growth in the coming growths, but falling consumption may push the country back towards a deflationary environment. Our economists have updated their CPI profile on Japan and now expect inflation to reach 1.3%y/y for 2008. There are upside risks to this view due to higher energy costs, but we still expect policy rates to remain at 0.5% for the rest of the year. We expect the JPY to find support ahead as risk aversion wanes. Note that Japanese margin traders have been significantly adding to their short yen positions; short yen positions on the Tokyo Financial Exchange rose to Y324bn as of Friday, from Y198 bn last Monday. This is quite a sharp move and is a useful barometer of leveraged carry trade activity. We don't think it will last.

In releases yesterday, housing-related data were weak in both Australia and New Zealand. Home sales for April in New Zealand collapsed 13% m/m, 45.5%y/y. The number is the lowest in 16 years, and the REINZ said the drop in sales during the month was a sign that confidence the housing market was "much deeper than anticipated". The data comes on the back of a weak employment report from last week and confirms fears of a sharp slowdown in the country. The RBNZ would need to see inflation-related data coming down before signaling an easing and this week's food price index and produce price index are expected to highlight the contribution of food and oil/fuel to high headline inflationary pressures. In Australia, housing finance numbers were released, showing a 6.1% fall in March in total lending, far weaker than expectations of a -0.8% drop. The NAB business survey for April also showed a further fall in business confidence, to -8 from -4, and the number is the lowest since September 2001. Our economists note that yesterday's data is evidence of further slowing in demand growth, as needed by the RBA before easing is contemplated. The central bank remains on a neutral footing for now but downside risks are increasingly evident. We are short NZDCAD based on the view that NZ growth is slowing sharply but high oil prices are supportive of CAD.

Norway April CPI released Friday came in above market's expectations accelerating 2.4% y/y from 2.1% y/y in March. Consensus was for 2.3% y/y in the underlying measure. At its latest policy meeting Norges Bank raised its depo rate 25bp to 5.50% and signalled rates may rise further in Q3 should price pressures persist. Norges Bank has been one of the few central banks in G10 space who remained on a tightening path despite the outburst of the credit crunch. So far Norway has not been substantially impacted by the crisis, however evidence of tighter credit conditions in the lending market and moderating domestic activity suggest that the central bank may be overly optimistic. Friday's release does represent risk Norges Bank may consider a further hike, however our economists argue the next move in Norway will be down, in 2009. Weaker global growth, in particular in the Eurozone and other Norwegian trading partners, will inevitably hurt Norway's economy in the months ahead, so that rates remain on hold. We continue to target EURNOK at 7.80 over 1 month and 7.95 over 3 months.