US Dollar
With the US markets closed for Presidents’ Day and many Asian markets closed for the Lunar New Year, trading has been extremely quiet in the foreign exchange market. News from Japan, the UK and the Eurozone have been driving the dollar’s fluctuations and we expect this to continue for the remainder of the week since consumer prices is the only piece of notable US economic data on the calendar. The global trend of inflation has been lower and because of that, consumer price growth in the US should slow in the month of January. The producer price report released last week has exhibited weakness which suggests that CPI has a far greater likelihood of surprising to the downside as well. The lack of US data aside from CPI should support further gains in the Euro. The Federal Reserve’s wait and see attitude comes in stark contrast to the European Central Bank’s clear and vocal plans to raise interest rates next month. This dynamic has narrowed the spread between the December 2007 Eurodollar (US) and Euribor (Eurozone) interest rates by 9 basis points over the past week. The recent disappointments in US data including last week’s Philly Fed survey, jobless claims, housing starts, consumer confidence and producer prices have pushed out expectations for an interest rate hike by the Federal Reserve from the first quarter of this year to the second or third quarter at the earliest.

Euro
The Euro has started the new trading week on a firmer footing as technical traders continue to drive the currency pair higher after last week’s upside breakout. The Eurozone economy has been exhibiting impressive strength for the past month and the currency’s latest movements reflect that. In the week ahead, the Eurozone economic calendar is far busier than the US calendar. We expect backward looking data such as French and German GDP to confirm the region’s improving growth and validate the central bank’s plans to raise interest rates. Consumer and producer price growth will probably slow like it has in the rest of the world so any disappointments should not be a major surprise, especially since it will not stop the ECB from raising interest rates again next month. The most important release of the week is the German IFO business sentiment report. Most of the growth that we have seen thus far has been driven by a rush of year end consumer spending ahead of the value added tax increase in Germany last month. However now that the tax increase is in place, we should begin to see a moderate slowdown in growth that could take a toll on business sentiment. Having reached the highest level on record back in December, optimism is expected to recede in February. Unless we see a major drop in sentiment, the German IFO reading remains at a healthy rate and as such, a mild retracement should have a limited impact on the Euro. Over in Switzerland, producer prices and the trade balance are due for release. The reports should be offsetting as producer prices are expected to drop while the trade surplus is expected to rise.

British Pound
Even though the British pound ended the day virtually unchanged, the currency pair’s V shaped intraday recovery made it one of the most interesting pairs to trade. Sparking the commotion was a written testimony by the Bank of England to the Treasury Select Committee. According to the report, the trade weighted pound is overvalued and is expected to move lower to close the current account deficit. The Bank of England also noted that inflationary pressures has ebbed and have become unusually stable. This follows last week’s report from the National Statistics Office that revealed a 0.8 percent drop in prices in the month of January. However the weakness in the British pound did not last long as the market tries to figure whether the Bank of England will still raise interest rates in March. Given the recent weakness in UK economic data, the odds for a rate hike are slim. Yet today’s recovery in the British pound suggests that traders do not want to be short going into the release of the minutes from the Bank of England monetary policy meeting earlier this month. If the decision to leave rates unchanged was unanimous, then the odds for a rate hike in March will be very low. If at least 2 members voted in favor of a rate hike, then market expectations will quickly adjust to reflect the possibility of 5.50 percent rates next month.

Japanese Yen
The Bank of Japan’s interest rate decision scheduled for Wednesday morning Tokyo time is this week’s most important economic release. The continual rise in Japanese stocks has helped to boost rate hike expectations. On Friday, the odds were essentially 50-50 for a rate hike but now they are closer to 65-35. Former Deputy Governor Fujiwara said overnight that this is the right time for the BoJ to raise interest rates. However aside from strong fourth quarter GDP numbers and the potential for a behind the scenes agreement between the Europeans and the Japanese at this month’s G7 meeting, there is no strong reason for the BoJ to deliver an early rate hike. Growth is improving, but there aren’t any signs of a significant pickup in inflation and consumer consumption. Either way expect the Japanese Yen to be a big market mover next week.

Commodity Currencies (CAD, AUD, NZD)
Canadian data took center stage today with both international securities transactions and wholesale data scheduled for the President’s Day holiday. Rising by 2.7 percent, wholesale sales saw the biggest increase in more than two years and tripled consensus estimates. However, the figure was supported by higher sales in automobiles, usually considered a volatile sub component. Nonetheless, the report does put the Canadian economy in a positive light as it follows manufacturing and home sale up ticks in the past month. The notion supports the possibility that rate hike considerations may be on the longer term horizon, boosting Canadian bullishness in the near term. The currency remained weaker, however, as the international securities transactions data fell short of expectations. Foreign sources sold C$3.26 billion in Canadian securities in December after increasing their purchases by C$11.2 billion the prior month. The Australian dollar remained virtually unchanged while the New Zealand dollar staged a strong rally that is most likely linked to yen selling given the sharp move higher in NZD/JPY today.

Kathy Lien is the Chief Currency Strategist at FXCM.