The Pressure on the US Dollar
The currency market has been exceptionally quiet over the past few days with the EUR/USD and USD/JPY confined within a tight trading range. This range however was broken today as the EUR/USD came within 50 pips of its record high. Although there was no meaningful US economic data released, the move in the dollar represents the pressure that the market expects to fall upon the greenback over the next 24 hours. The European Central Bank and the Bank of England have monetary policy announcements. The former is expected to keep rates unchanged while the latter is expected to lower them. However for the US dollar, the relative dovishness of the Federal Reserve may be the most important. The minutes from the last FOMC meeting reveals a divided Fed that is concerned about both growth and inflation. Although from here on forward, the Fed could slow down their degree of easing, the ECB’s reluctance to cut interest rates and the BoE’s own internal struggles (read the EUR and GBP sections for more details) could keep pressure on the US dollar. Furthermore, the US trade balance could also turn out to be dollar negative. Even though the greenback has weakened significantly, which should help to narrow the trade deficit, manufacturing ISM also slipped that month which suggests that the contribution may have been limited. There are still a lot of inherent problems in the US economy. We have previously warned of a further deterioration in the US labor market, but more immediately, US retail sales are expected to be released on Monday. With Linens ‘n Things joining Domain, Fortunoff, and Sharper Image in filing for bankruptcy protection, there is a decent chance that consumer spending could contract for another month. Crude oil and gasoline prices have also hit a record high which will take a toll on the pocketbooks of nearly all Americans. It may not be long before gas prices hit $4 a gallon across the nation.

How Many Times Will Trichet Use the Words Price Stability
The Euro has come within 50 pips of its all time record high against the US dollar ahead of the ECB interest rate decision. The latest price action suggest that the the notoriously stubborn ECB President will continue to remain hawkish and express no concern about the level of the currency. Although retail sales have dipped, industrial production and the trade balance is on the rise. The improvement in the trade picture is particularly important because it confirms that the strength of the Euro continues to have only a limited impact on the Eurozone economy. At the last monetary meeting, Trichet used the words “price stability” 8 times in his Introductory Statement. Although the ECB lowered their growth forecasts at the time, they also upgraded their inflation forecasts, sending a strong message to the markets that interest rates will remain unchanged for some tine. Looking ahead to this interest rate meeting, as long as the tone of the press conference remains the same and price stability is used no less than 8 times, there is a decent chance that the EUR/USD could hit a new all time high. However should Trichet acknowledge the slowdown in growth, expect the EUR/USD to top out below 1.60 once again.

Bank of England: 25 or 50?
Even though the market is dedicating the bulk of its attention to the ECB monetary policy meeting, the Bank of England announcement is actually the one that could lead to more volatility in the currency market. The BoE is expected to cut interest rates by 25bp, but there is a small chance of a 50bp reduction. Conditions in the UK housing market have steadily gone from bad to worse with prices falling by the most since 1992 and mortgage approvals dwindling to the lowest since 1995. However like the ECB the Bank of England struggles with inflationary pressures. Bank of England Governor King is committed to making sure that inflation does not become entrenched but comments from UK Prime Minister Gordon Brown suggests that the most likely option by the BoE is still a quarter point rate cut. Brown told BBC news that “because we’ve got low inflation we can cut interest rates.” How the British pound reacts to the latest interest rate cut will depend upon whether the BoE signals more easing. Getting a rate cut from the BoE has been like pulling teeth which is why we expect more neutral comments from the UK central bank.

Commodity Currencies Give Back Gains
The US Dollar has made a surprising U-turn against the commodity currencies. With minimal releases today, the Aussie dollar lost ground as consumer confidence figures hit a 15 year low. The Australian economy is beginning to show signs of weakness and for that reason, we expect the unemployment rate to tick higher. After 4 months of strong job growth, Australian corporations are only expected to add 10K new jobs. New Zealand also did not report any new data, but investors are still recovering from yesterday’s plunge in the business opinion survey. Canada on the other hand is set to release its New Housing Price Index, which is expected to decline, as the once resilient economy feels the pressure of a US slowdown. IMF officials confirm that Canada will be affected by a US slowdown, as they cut their growth forecasts to 1.3%.

Bank of Japan Keeps Rates Unchanged, Approves Shirakawa as Governor
The Bank of Japan kept interest rates unchanged at 0.5%, which was right in line with market expectations. The decision was unanimous because it was only the choice the central bank really had in the face of mixed economic data. The Japanese current account and trade balances are due for release tonight. The deterioration in the merchandise trade balance and manufacturing PMI suggests that the surplus could fall short of expectations. Meanwhile the BoJ no longer has a leadership vacuum as Shirakawa becomes the official BoJ Governor.

Kathy Lien is the Chief Currency Strategist at FXCM.