The US Dollar started out the week stronger against most of the majors, as better-than-expected retail sales helped quell fears that the subprime contagion would lead consumption growth to stall. Furthermore, multiple central banks – including the Federal Reserve, Bank of Japan, and European Central Bank – continued to inject liquidity into the money markets, which helped to stabilize global equities. Focusing on the economic data at hand, retail sales during the month of July rose a stronger-than-expected 0.3 percent. Excluding autos and gas, the reading was even more encouraging, as sales rose 0.6 percent from the month prior. A breakdown of the data shows that clothing purchases led the increase, which is somewhat surprising after apparel retailers such as Abercrombie & Fitch, Gap Inc., and American Eagle Outfitters Inc. all reported dismal same-store sales for the month. Nevertheless, it appears that heavy discounting by stores such as Wal-Mart helped keep July's headline reading afloat and should help alleviate some concerns that consumer spending growth has stalled, especially after consumption slowed dramatically in the second quarter GDP report. Markets will be anxiously awaiting Wednesday’s CPI report, as signs that price pressures remain uncomfortably high for the Fed could lead fixed income markets to stop pricing in a September rate cut, since the central bank is unlikely to risk letting inflation get out of hand in order to spare the equity markets.

Japanese Yen Weakens On Slower Economic Growth
The Japanese yen was slightly lower through overnight trade as gross domestic product for the second quarter showed less than exemplary results. Following a first quarter revised 3.2 percent rate of growth, the second quarter GDP assessment was far below at a 0.5 percent expansion. Being the last main economic indicator before policy makers meet to decide on interest rates on August 22-23, the figure lends to a greater likelihood of a stay on rates. This is in stark contrast to the previously overriding sentiment in the market which previously expected an imminent hike of 25 basis points from policy makers. Now, it seems that speculation has shifted, and will likely weigh on the Japanese yen in the near term, especially against carry candidates. Forecasts are pitting a 33 percent likelihood of a rate hike versus 75 percent earlier in the month. Going forward, policy makers will still likely remain pat on inflationary prevention as long as consumer spending remains timid as it has for the past year. Domestic spending continues to remain low as consumer confidence is being dampened by rising taxes and low wages, even as the unemployment rate dropped to a nine year low.

Reserve Bank of Australia Forecasts Higher Inflation
Although markets were privy to New Zealand food prices report, which increased by 1.2 percent and boosted the underlying currency incrementally in the overnight, attention was focused on the Reserve Bank of Australia monetary assessment. In statements that helped to support the Australian dollar briefly, monetary authorities noted that inflationary pressures are forecasted to accelerate even further into next year. Looking ahead, the statement notes that inflation is likely to heighten to 3 percent at the end of the year, and subsequently remain atop of the bank’s target range for much of the following year. Subsequently, the hawkish statements come not even a week after authorities decided to raise the benchmark overnight cash rate by 25 basis points. As a result, attention will be placed on Governor Glenn Stevens’ testimony to Parliament this week. A bold tone will all but solidify further speculation on another round of monetary tightening. Incidentally, on the Kiwi side of things, focus will fall on tonight’s retail sales figures. Expectations are for spending to pare back on higher interest rates.

With Pound Bidders On Vacation, Sterling Drops Further
Sterling bid tone continues to remain absent from the currency markets as it seems carry traders are paring back exposure ahead of the consumer price index survey expected out tomorrow morning. Usually, the pair would likely be bid up through the announcement, however, given the global credit crunch from last week, nerves may be a little on edge. Particularly because it also seems that expectations are for inflationary pressures to pare back in the UK economy. Yes, it’s true. In line with estimates forecasted by the Bank of England, it seems that consumer price increases may be pulling back as retail demand has turned down a bit. Suggestions of this could be seen months in advance as the market has been privy to consumer retail spending figures that have remained slightly under expectations. Now, this is not to say that consumers have all but left the arena leaving economic growth to the downside. Merely it presents room for BoE policy makers in denying the speculative public of another rate hike past six percent. Either way, tomorrow’s report will very well spell the pound’s near term future until the meeting minutes release in midweek action.

ECB Continues To Add Liquidity
With little economic data on tap for the Euro, the underlying currency fell to the mercy of what has been evolving for the past couple of sessions. Markets still wary of risk and exposure continued to pare back in carry trades involving the Euro, taking the currency lower through to support at 1.3600 briefly in New York. Exacerbating the decline seemed to be concerns over the third allotment of cash to banks as the ECB lent 47.4 billion euros to institutions for the third straight day. However, to the rescue. It was IMF comments that helped to stem losses further throughout the day as officials noted that the “re-assessment of credit risk that is taking place will be manageable”. The statements are likely to shift market focus back to rate increases in the near term as ECB officials are set to raise rates by another 25 basis points to curb looming inflationary pressures.

Richard Lee is a Currency Strategist at FXCM.