www.dailyfx.com .. Will the UK be the First Major Country to Lower Interest Rates?,Euro Breaks… … Higher Following Another Batch of Good News,Japanese Yen Continues to Soar Ahead of Postal Privatization Vote

US Dollar – As we postulated yesterday, the fourth time's indeed the charm. The
Euro has finally managed to breach the 1.2250 barrier against the dollar on nothing
more than another set of positive Eurozone economic data. We had mild
disappointments here in the US with a weaker than expected service sector ISM report
which eased to 60.5 from 62.2. Given that anything above 60 is still expansionary,
the dollar barely reacted on the back of the release. Most of the action occurred
in the early European trading session with the dollar gradually grinding lower
during the US session. Even an optimistic Challenger report did little to help the
dollar recoup some of its losses. According to the Challenger Group, there were 7%
less layoff announcements in the month of July compared to the month of June. The
1.2350 barrier is now the next key level, but it is being staunchly defended with
lots of rumors of people defending option barriers at that level. Although the
market will be paying heed to the rate decisions by the Bank of England and European
Central Bank tomorrow, the US session should be spent pondering how non-farm
payrolls may fare on Friday. Yesterday we said that non-farm payrolls are expected
to be strong in the month of July with the average of jobless claims at 316k
compared to the first half average of 326k, help wanted ads are up, layoffs are down
while the employment component of the ISM manufacturing survey rebounded back into
expansionary from contractionary territory. The employment component of the service
ISM remained unchanged. With signs of a recovery across the board in the
manufacturing sector, we wouldn't be surprised to see job growth in sector for the
first time in 4 months.

Euro – The Euro has now rallied for the sixth consecutive day against the dollar.
It is becoming increasingly clear that the Eurozone economy has already hit the
bottom and is now headed higher from here. Service sector PMI for the region
increased to 53.5 from 53.1 in June. Not surprisingly, improvements were seen in
Germany, the country that has been benefiting the most from the stimulative effect
of the previous sell-off in the Euro. The PMI index for Italy rebounded back to
neutral, indicating that the service sector did not grow or slow in the month of
July. France however experienced a slide in the index although it does remain in
expansionary territory. The real surprise today came in the retail trade index
which jumped to 0.4% compared to expectations for 0.1% growth. The icing on the
cake was the improvement in the business climate index which rose to 53.2 from 52.3.
Overall, the Eurozone is already on the path to a stronger growth for the second
half of the year. As a result of the recent turn in Eurozone data, ECB President
Trichet could very well make some optimistic comments tomorrow at the press
conference following the announcement of the ECB's interest rate decision. The ECB
is expected to keep rates unchanged for the 14th consecutive month.

British Pound – The Bank of England's Monetary Policy Committee began its two day
meeting today to discuss changes in interest rates. This may actually be one of the
most interesting meetings that we have had in a while. Although the BoE is expected
to lower rates for the first time in a year, skeptics are starting to loom with some
experts feeling that the economic situation in Europe's second largest economy is
not as bad as they initially expected. However, there still remains some key bits
of evidence that make the 25 basis point cut decision the more likely scenario.
Declines in manufacturing and industrial production have remained key to proponents
of the benchmark rate cut. Additionally, dips in consumer spending and paltry
retail sales and volume figures, according to yesterday's CBI survey, have
contributed substantively to the notion. Subsequently, economists are now
considering current inflationary suggestions and the fact that consumer spending
figures aren't necessarily that bad. Inflation accelerated at the fastest pace in
seven years and matched the central bank's target rate of 2 percent. Consumer
prices also increased to an annualized 2 percent. This is a factor that policy
makers are also wary of as it remains an economic red light. Subsequently, although
traders are pricing in a definite reduction decision this time around, sentiment has
changed to suggest that policy makers will be reluctant in replicating the decision
till 2006 with short sterling futures confirming the shift.

Japanese Yen – The Japanese yen rallied against the dollar for the third day in a
row. Relatively odd considering that crude oil prices are still very lofty, the
current strength looks to be connected with growing bullish sentiment reflected in
Japanese equities and mounting speculation on the deflationary front Rarely noticed
in the first half of 2005, the Nikkei 225 has charged ahead in recent months,
briefly peaking above the psychological 12,000 mark. Still, closing at a 15 month
high, the higher benchmark index looks to be lending some strength to yen bulls.
With a seemingly stronger equities market, Japanese investor interest in domestic
investment may be renewed, ultimately capping outflows of yen capital which has
loomed over the markets. Additionally, widespread belief is that with growing
valuations, and additional upticks in the economy, the impact of higher energy costs
can now be discounted. Although recent strength, by no means suggest a new bull
market, it can attract foreign investors back to the economy. Subsequently, risks
still do exist as we approach the voting deadline for Koizumi's effort to privatize
the postal service. Hitting the wire today, representatives of the ruling Liberal
Democratic party placed pressure on the prime minister in not carrying out the
potential dissolution of the lower house. It seems that even staunch advocates of
Koizumi may be reconsidering their allegiance if such a situation is created,
placing the prime minister in an awkward situation.

Kindest Regards,

Kathy Lien
Chief Strategist
Forex Capital Markets LLC
32 Old Slip, 10th Floor
New York, NY 10004
Tel (212) 897-7660
Fax (212) 897-7669
E-mail: klien@fxcm.com

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