Much better results from the IFO survey verticalized the EUR/USD in early European trade today propelling the pair comfortably above the critical 1.2000 barrier.  The IFO institute reported a reading of 98.7 vs. market expectations of only 96.1 as both lower exchange rates  and lower oil prices boosted business confidence in the export sensitive region. The IFO produced the highest  results in five years sending the strongest signal yet that Euro-zone economy is on the mend. The report caused the Bund/T-note spread to narrow by 3 basis points on the day as the fixed income markets started to price in a possible rate hike by the ECB at the beginning of 2006.

Over the past 6 months the greenback's yield advantage over the euro has been the cornerstone of the dollar rally.  Recently however, market's expectations of further US rate hikes after November have been dampened by fears of a slowdown in consumer spending. While 4.25% rate is taken as a given by most  market players, the 4.5% target is far more problematic.  Therefore we may just be witnessing the start of a turn in the interest rate cycle process with the ECB on the verge of commencing rate hikes while the Fed begins to relax its  monetary tightening bias.  Clearly such policy changes are still months away, however, should such dynamic develop the long term implications of these moves would favor a euro rally. Meanwhile on the more immediate front, the EUR/USD needs to hold the 1.2000 level if euro longs are to have any realistic chance of seeing further gains in the week ahead. On the agenda for today and tomorrow * US housing data which should cast some light on the state of affairs in one of the most critical sectors of the US economy.

Boris Schlossberg is a Senior Currency Strategist at FXCM.