Berlusconi can’t dent the Euro!!!

The dollar remains softer as we end the week and the month despite some controversial comments (to say the least!) by Italian Prime Minister Silvio Berlusconi yesterday. He blamed the nation’s economic difficulties on the Euro and the way that Romano Prodi, his political arch-rival, steered Italy into Europe’s monetary union. In contrast in June after the French referendum, such comments would have caused the Euro to fall sharply.

Whilst the dollar has been consistently strong in recent months and weeks speculation is now growing that all the good economic news is now “priced in” and the USD is indeed now more vulnerable to downside surprises rather than surprises on the upside. In particular against the Euro the dollars four failed attempts to breach the $1.2000 level in the past two weeks suggests momentum is waning.

Two key data releases today will be the Eurozone CPI inflation for July and U.S 2ndquarter GDP.

In Europe higher oil prices pushed inflation up from 2.0% to 2.1% in June and are expected to push it up to 2.2% in July. Much focus will be on the US GDP number where expectations are for a rise in the region of 3.3%.

Next week the Bank of England MPC meet and Investors are increasingly gunning for a quarter point interest rate cut to 4.50%. In the latest Bloomberg survey of 36 banks, some 31 forecast a 25bp reduction. However, perhaps the bigger story is the way investors are viewing the MPC after that. History would suggest the policy committee dropping into a fairly aggressive rate cutting cycle. In the past it has tended to maintain rates for lengthy periods, and then move (one way or the other) in very quick succession.

This time round, many feel the MPC will operate quite differently indeed, with next week's expected cut an isolated 'insurance' measure. The economy isn't especially weak, but with consumer spending waning a little, there is a feeling that CPI could just undershoot the 2.0% target, hence just a small measured move.

If the BOE emphasises this uncharacteristic fine tuning in the August inflation report (published just 6 days after the MPC conclusion), then the market may need to quickly adjust from its current positioning for a further rate cut around the turn of the year.

US Dollar drops despite strong durables

Following some very robust industrial data out of the US yesterday, the Greenback had an initial flutter towards highs against the Euro and Sterling. However, as the big Dollar failed to push through new levels following the Durable goods figures, investors sold off USD against the Euro.

US durable goods orders rose 1.4% in June, and the rise in May was revised up to 6.4% from 5.5% - not bad at all.

With very little in the way of economic data to get excited about today, attention moves to tomorrow’s US second quarter GDP figure. Strong data out of the US recently suggests a solid outcome for Q2 GDP, with markets expecting a figure of 3.5% (annualised). As the raft of robust economic data continues to flow from across the Atlantic, global investors continue to eye US interest rates with enthusiasm. The Fed Reserve has raised interest rates at nine straight meetings taking the fed funds to 3.25%. However, to put a spanner in the works, the Fed’s Beige Book released last night was considerably more subdued than recent months. Markets had expected an upbeat trend to continue – watch this space…

Locally, from the Nationwide housing survey this morning, house price inflation in the UK has dipped to its lowest level for over nine years. The survey said house prices in July rose 0.2% from the previous month, reversing June's fall, the annual rate of increase dipped from 4.1% in June to 2.6%, the lowest rate since May 1996. Only a year ago, annual house price inflation was standing at 20%!

And for those who are interested the Reserve Bank of New Zealand kept interest rates on hold overnight at 6.75%.

Focus shifts to the US and Europe as little impact of Chinese revaluation realised

The improvement in yesterday’s Ifo business climate survey contained mixed sentiment from retailers and executives. The survey stated that optimism among retailers declined in July, partly on concern about the Christian Democratic Union’s proposals.

The CDU, which leads Chancellor Gerhard Schroeder’s Social Democratic Party in national polls ahead of September’s election, says it will use revenue from VAT to cut employers ‘ wage burdens and boost employment prospects.

This was also reflected in a decline in consumer confidence in Germany’s Gfk index for a 4th month as unemployment stayed close to a record high.

German consumers’ pessimism however, is at odds with more positive economic data in recent weeks. Optimism among German execs unexpectedly rose to a 5-month high in July, Ifo said yesterday, as the euro’s 11% decline against the dollar in 2005 boosts prospects for exporters.

The yield on Germany’s 10-year bonds yesterday rose the most since July 14 from the German figures and improved business sentiment in Italy. European bonds may fall after a survey showed business confidence in France rose more than forecast to a 4-month high (from 99 to 101, forecast was for 100).

Over is Asia, speculative interpretation ceased as the realisation ensued that the revaluation has had a little impact economically…at least not until the next move.

In Japan, bonds fell, pushing 10-year yields to their highest in a month after Reuters reported that some central bank members expected deflation to end this year. The BOJ kept interest rates almost at zero and maintained the pace at which it pumps cash into the world’s 2nd largest economy as it struggles to overcome deflation of more than 7 years.

Yesterday’s CBI figure from the UK came in at +6, the first positive output balance since April (from -5). However, in quarterly terms, output balance remained negative at -1 in the three months compared with -10 in April. CBI’s Ian Mc Cafferty said that the weak quarterly results would“reinforce the case for a cut in interest rates on August 4”.

Stateside, consumer confidence slipped to 103.2 in July from 106.2 in the prior month. During the first 6 months of 2005, consumer confidence averaged 103.2 so there’s very little change. US 10-year treasuries may rise in Europe on expectations that durable goods orders fell in June for the first time in three months.

Orders probably fell because of fewer bookings for Boeing Co. aircraft. Excluding transportation equipment, a volatile category swayed by aircraft, orders probably rose by the most this year. The Commerce Department is due to release figures at 08.30am in Washington (1.30 BST).

Demand may also increase for 10-year treasuries pending a release on Friday at 1.30pm BST of Q2 GDP for the US, that is forecast to show economic growth was slower in Q2 compared to Q1.

Look out for New Homes sales from the US out at 3.00pm BST and the Beige Book at 7.00pm BST.

A a quick glance at commodities, gold headed for a 1-week low as a stronger dollar made the precious metal more expensive for buyers using other currencies. Crude oil fell in New York for the first day in four on speculation that an Energy Department report today will show US inventories of distillates, including heating oil and diesel, rose for a tenth straight week. Futures touched $62.10 a barrel on July 7, the highest for the contract nearest expiration since trading began in 1983.

Focus remains on China and UK outlook appears weaker

Talk is still on China this morning as the yen fell against the dollar and euro for a third day on speculation that China will delay any further strength in the yuan, limiting the benefit to the competitiveness of Japanese exports. However, statements from Asia yesterday attempted to clarify speculation of China’s prospective future moves.

Japanese Finance minister Sadakazu Tanigaki said yesterday at a regular press conference in Tokyo after the Cabinet met stated that “It’s too early to evaluate China’s action…we must closely watch how China manages the currency”.

Li Jen believes currency flexibility is Beijing’s ultimate objective, so as to enhance the ability of the PBOC to be more independent from the Fed’s policy. He thinks the market’s interpretation that China is doing this to help reduce the record US deficit is a gross misunderstanding.

Elsewhere in Asia, Bank of Japan policy makers will probably keep interest rates at almost zero and pump cash into the world’s second biggest economy at the same pace this week as they seek to send seven years of deflation, economists said.

South Korea’s economy grew in Q2 at the fastest pace in more than a year as consumer spending, investment and construction picked up.

Strong housing numbers from the States yesterday highlight the robust economy there, again predicating higher interest rates and more support for the dollar (especially against low yielding currencies such as the JPY).

The dollar also strengthened as the US Conference Board’s index of consumer confidence probably rose this month to 106.2, the highest in 3 years. Figures are released at 3.00pm BST).

On commodities, gold declined from a two-week high before US figure releases this week, eroding the appeal of the metal as an alternative investment.

As predicted, BP Plc, Europe’s biggest oil company, said that Q2 profit surged 29% as prices jumped for crude oil, gasoline and other fuels.

The world’s 70 biggest oil companies are expected to report a net income this year of $230bn, 26% more than last year. The total is almost as big as Poland’s economy!!

In the UK, gilts may advance for a 2nd day as slowing growth in Europe’s second biggest economy increases the appeal of UK government debt. The Confederation of British Industry’s index of factory orders probably rose modestly (out at 11.00 BST) and gilts may offer better value from a risk perspective on the back of this. The pound may fall if speculation is correct that UK factory orders stay near its lowest in more than 18 months however.

Higher Oil and Gold prices after Chinese revaluation and terrorist scares…

After the flurry of activity last week and the unfortunate events of last Thursday in which no one was hurt thankfully, today begins quieter with the only prominent out for release is US existing home sales for June (3.00pm BST).

Last week’s Q1 GDP growth came out as low as expected growing q-o-q 0.4% and 1.7% y-o-y, the slowest quarterly growth in the UK economy since December 1993.

Property website Hometrack showed that UK house prices fell for a 13th month in July, reinforcing speculation that the Bank of England will cut the base rate as soon as next week.

Stateside, there are a number of figure releases this week including Consumer Confidence for July which probably rose 106.2 it is forecast, the highest in three years (due at 3.00 BST tomorrow). This will reinforce the antithetical effect on US interest rates, signalling their probable continued hike.

The US government will announce today the amount of two-year notes it will sell in two days. The treasury will probably sell $20bn of the securities. Yields on two-year notes are close to its highest in almost four years on expectations that the Federal Reserve will continue to raise rates to keep inflation from accelerating. Two-year securities are among the most sensitive to changes in interest rates.

Lastly, declines in treasuries may be tempered by expectations that durable good orders declined last month (released at 1.30 BST Wednesday).

On the commodities front, crude oil was little changed after rising on speculation that a stronger Chinese currency will encourage refiners to buy more crude oil as imports gets cheaper. Exxon Mobil Corp., B.P. Plc and Royal Dutch Shell Plc, the world’s three biggest publicly traded oil companies, this week will probably report record Q2 profits because of surging oil and gas prices. World oil consumption is forecast to rise 2% this year, led by rising demand in the US and China, the world’s largest consumers, OPEC said in a forecast last week. They added that demand in China will rise a whopping 6.1% from a year ago.

Gold may rise for a second straight week as well on speculation that a revaluation of the Chinese Yuan will increase jewellery sales in Asia and demand for the precious metal as a hedge against a falling dollar. Gold for August delivery rose $3.70 ounce last week, surprising the majority of analysts who expected a decline.

The yuan looks to be the biggest story driving commodities such as gold coupled with the speculation of more terrorist attacks which may disrupt global financial markets.

Watch out also for the German IFO-business climate survey out at 9.00am BST tomorrow. Business confidence in Germany, France and Italy, the biggest EU economies probably rose in July as the euro’s decline helped exports.