• Dollar Gives Back Gains Ahead of Critical Data
• Euro Surges as ECB Reaffirms Hawkish Bias
• Pound Rebounds Despite Weaker Economic Data

US Dollar
It has been a rock and roll day in the currency markets with the dollar first rallying within 10 pips of its 3 month high on the back of better than expected economic data but then to erase nearly all of its gains in the late afternoon session.  Profit taking near the lows was the primary reason for the reversal along with some hawkish comments out of Europe.  Even though we had some dollar positive data today, traders have been holding out for tomorrow's releases, which are far more important and uncertain.  We will be expecting the consumer price index, retail sales, industrial production and consumer confidence.   The fear is that even though energy prices should drive the headline CPI number higher, growth in core prices could be far more subdued.  Also, retail sales and industrial production face the risk of coming out worse than expected.  September was a tough month and industrial production is already expected to come in negative. Today's reports though do provide a glimmer of hope for US rates. Import prices rose by the largest amount in 15 years, bolstering inflation fears while the trade deficit came in narrower than expected.  However, jobless claims, which have become much less marketing moving than before because of the resilience of the labor market, did come in weaker than expected, falling to 389k instead of 360k.  For the time being, dollar bullish sentiment still remains the bias in the markets and unless we get some meaningful evidence to shift perceptions or a sharp technical reversal, we don't expect much to change.

Euro
The ECB's reaffirmation of their hawkish stance helped to send the euro higher today.  In their October monthly report, the central bank raised a cautionary tone about inflation, warning that high current numbers cannot be allowed to translate into higher underlying pressure.  These comments strengthened feelings that the ECB will raise rates next year.  Meanwhile Euro-zone GDP in the second quarter grew as expected and in line with the first quarter at .3% from last quarter and 1.1% yoy.  The European Commission's third and fourth quarter forecasts were little changed from earlier projections and show that this growth will steadily continue for the rest of the year, being pushed by a rise in export demand.  Along with the collective data, individual countries released key reports as well.  The French consumer price index rose .4% from August to September with a 2.2% yoy rise, coming in .1 and .2% points respectively higher than expected.  These numbers rose at the highest level in 13 months as companies had to raise prices to cover costs incurred by rising energy prices.  Italian industrial production rose for the second month, more than 3 times more than expected by 1.3% from July to August the second biggest increase in more than 8 years fueled by the decline in the euro pushing up export demand and cushioning the impact of high oil prices.  This strong recovery in production is not expected to last forever though being that energy prices have to be felt eventually. 

British Pound
Like the Euro, the British pound first dropped against the dollar before recuperating gains in the US session. Data released this morning intensified worries of a slowing economy.  The BCC released the Quarterly Economic Survey for Q3 this morning, showing alarming results at a time when some economists were expecting to see at least a slight improvement.  There was a decline in confidence across all sectors.  Manufacturing failed to sustain recovery and dropped across the board including home sales and orders, export sales and orders, employment, cash flow, and both key confidence balances.  The service sector showed mixed sentiment but still was disappointing overall seeing only mild improvements in some parts after sharp losses earlier this year.  Troubling was the drop seen in all export balances, signaling that the planned cut in export funding may need to be reconsidered.  This negative data also strengthens the argument supporting a drop in the lending rate at the next meeting of the MPC in order to halt falling business sentiments.  Also released today were the Leading Indicators Index and the Coincident Indicators Index for August, both of which increased by .1%.  The leading index, which, in a revised number, grew .5% last month, has actually been declining at about 1 to 2% annually for the past few months, a stark contrast to the 7 percent annual increase seen in mid 2004.  Six of the eight indicators used in the index actually rose, led by volume of expected output, but the increase was only slight. Industrial production dropped in August mostly canceling out gains in other parts of the index.  This continuing trend of small growth in the indexes is signally that economic growth for the fourth quarter will be rather lethargic.

Japanese Yen
The Japanese yen hit its lowest level against the dollar since last May before regaining ground in the late US session. Mixed data provided little direction for the Japanese Yen.   Japan's most widely watched measure of money supply, M2 plus CDs, for September rose more than expected, by 2.1% from September 2004 * the biggest gain since March, after a 1.7% rise in August.  This acceleration in money supply growth is seen as crucial to continue economic recovery and to end deflation.  The decline in outstanding bank loans also slowed, dropping 1.6%, versus the expected 1.8%, from September 2004 * the smallest decline since calculations began in January 2001, an improvement over last month's drop of 1.9 %.  Broad liquidity for September year-over-year rose by 2.6 %, the same as August, coming in .1 % higher than expected. These indicators signal evidence of a continuing recovery in business conditions in the country as small business owners are beginning to invest in expansion.  The trade surplus for August, in contrast, came out rather disappointing this morning, shrinking more than expected.  Imports increased due to rising domestic demand stemming from a recovering economy, amplified by the fact that record high oil prices in August caused an increase in the value of Japanese imports.  Meanwhile the Bank of Japan left monetary policy unchanged, which was in line with expectations. 

Kathy Lien is the Chief Currency Strategist at FXCM.