US Dollar
The stronger than expected US service sector ISM report was not enough to change the prevailing themes in the currency market. Traders are focused on 4 things this week and these 4 things will continue to be the market’s primary drivers. The first is the overall health of the US economy. US data was strong on Friday and today’s service sector report continues to confirm that strength. However the Fed needs to see this growth continue over the next month or two before considering a rate hike and as result we need the same as well. Therefore even though there is no more meaningful data this week, the bias in the market is still for more dollar strength than weakness. The second is the G7 finance ministers meeting this weekend. Short yen traders are liquidating their positions ahead of the meeting which explains the dollar’s underperformance against the Yen despite its out performance against the Euro and British pound. Although we do not think that the G7 will raise an official concern about the Yen’s weakness, the fact that the yen dropped close to 400 pips in the less than 48 hours after the April 2006 G7 meeting is enough reason for some USD/JPY bulls to take profits here. The third focus is the ECB meeting on Thursday. Although no interest rate changes are expected to be made, traders expect the next ECB rate hike to be the last and are punishing the Euro as a result. Therefore ECB President Trichet’s affirmation or denial of that will be a big driver of market activity. Finally, the fourth market mover this week is oil prices. It has so far received little notice in the currency market, but at $58.70 a barrel, the rebound may be significant enough for Fed officials to comment about it this week. Paulson, Bernanke, Moskow and Yellen are all scheduled to speak tomorrow so even though there is no data, keep an eye out for market moving comments.

Euro
Despite stronger service sector PMI, the Euro has dropped right back into its month long trading range. Germany, France and Italy all reported faster service sector activity, driving the regional index up from 56.8 to 57.9. However despite the growth, the market is still trading off of the Market News report released on Friday which speculated that the central bank will pause on rates after raising them in March. Economic data has been mixed and it may be too early to tell whether the ECB will put an end to their tightening cycle especially now that oil prices are higher. ECB member Draghi said this morning that growth rates remain robust and liquidity is abundant, signaling that more rate hikes are in store. We are expecting Eurozone retail sales tomorrow which are expected to print strongly after the sharp rise in German sales last week. However this continues to be data from December and we will have to wait another week before seeing data that may actually incorporate some of the impact of the value added tax increase. Furthermore, European government officials have been calling for the yen to stop falling against the Euro. On a small level, their wishes were answered as EUR/JPY fell close to 1 percent, earning it the title of the day’s most market moving currency pair.

British Pound
The British pound was weighed down by a weaker service sector PMI figure. The index dipped to 59.2, falling from a nine and a half year high 60.6. Although not as bad as some had anticipated, about 0.8 points lower than the estimate, the survey results hold mixed notions for the upcoming Bank of England rate decision. Specifically, both expectations and employment sub-indexes dipped for the month, supporting a rate cut bias. However, still supportive of a likely rate cut is the fact that prices advanced in January. Taking a look at the sub-index, average prices charged rose to the highest measure since August, printing a 55.2. The figure climbed from the December number of 53.2. Input prices also jumped higher, rising to 60.1, the highest since last September. A mouthful, the survey’s sub-indexes simply show that prices are still elevated in the economy and may lead to higher consumer prices in the near term, lending to a likely hike. However, given the current production and employment measures, spending may once again be at risk. The emergence of this weakness could jeopardize the highly touted aggressiveness of the Bank of England through the year, leading to the next hike being the bank’s last.

Japanese Yen
With the G7 meeting scheduled for this weekend, it is hardly surprising that the Yen is the day’s biggest market mover. The latest drop was triggered by speculation on the government run television network NHK, that European nations will force the weak Yen to be a discussion topic at the G7 meeting. This was further confirmed by Eurogroup head Junker. However, these discussions will most likely be sideline discussions rather than an official one that makes it to the statement. The US is far too concerned about China at the moment to worry about the Yen, especially since the Yen is not trading at any significant levels against the US dollar. Nevertheless, the G7 meeting has led to huge market swings and just the possibility of that is enough to cause some short yen traders to take profit.

Commodity Currencies (CAD, AUD, NZD)
Lots of commodity strength on the day as the Canadian, Australian and New Zealand dollars made some headway against the US dollar. In the overnight, Australia’s retail sales pared back from previous gains along with consumer prices. It seems that now after raising rates last year, the Reserve Bank of Australia is getting their wish of lower spending and cooler inflationary pressures in the country. According to the Bureau of Statistics, retail sales figures rose less than expected, advancing only 0.3 percent in the month. Subsequently, consumer prices, the main focus, cooled from a 3.3 percent pace to 3.1 percent on the annualized figure. What does this mean? It simply means that rates are finally helping in curbing consumer enthusiasm, allowing the RBA some leeway in issuing monetary policy. As a result, although likely to not raise rates this time around, policy makers have an option should issues flare up. Separately, according to the Ivey PMI, Canadian business and government spending picked up for the first time in 4 months in January. The index rose to 53.8, considered bullish for the CAD, as production expanded in the economy. Coupled with higher crude prices on a Northeastern cold snap, the report gave the Canadian currency a temporary lift.

Kathy Lien is the Chief Currency Strategist at FXCM.