Market Report

Currency forecasters grew more bullish on the U.K. pound after a surprise interest-rate increase yesterday by the Bank of England. Investors pushed the pound to an 18-month high against the euro after the central bank unexpectedly lifted its benchmark rate to a five-year high of 5.25 percent, while the European Central Bank left borrowing costs unchanged. All 52 economists in a Bloomberg survey had predicted no change to U.K. rates. The U.K. pound headed for its biggest weekly advance in 20 months versus the euro on speculation the Bank of England will keep on raising interest rates. The pound is at its highest since June 2005. Interest-rate futures now show investors expect the BOE to lift rates a further quarter point by March, and are betting on more than 50 percent odds of rates going to 5.75 percent by June. The U.K. economy grew at an above- average clip in the fourth quarter, justifying yesterday's surprise interest-rate increase by the Bank of England. The economy expanded at a quarterly rate of 0.7 percent in the three months through December, exceeding the average of the past decade and matching the pace of each of the previous four quarters. The institute's clients include the bank and the U.K. Treasury. This was the third increase since August. Inflation, at a decade high in November, may rise further above its 2 percent target as economic growth holds at a steady pace.

The Australian dollar headed for its first weekly gain of the year as a series of stronger-than-expected economic reports boosted bets the central bank will raise interest rates. The currency benefited as an employment report yesterday capped the biggest year of job gains since 1989. A surge in consumer confidence to a 17-month high and increasing building approvals signal the Reserve Bank of Australia's three rate increases in 2006 have failed to slow demand in the economy.

The dollar was poised for the biggest weekly gain against the yen since August before a U.S. government report today that will probably show retail sales are spurring the expansion in the world's largest economy. The U.S. currency rose to the highest in 13 months versus the yen as traders cut bets the Federal Reserve will lower interest rates. Fed officials this week said inflation remains a greater threat than slowing economic growth. The yield premium on two-year U.S. Treasuries over similar-maturity Japanese debt this week widened to the most in two months.

LR

The Bank of England will probably keep its benchmark interest rate unchanged today, allowing the economy to digest a November increase. A growing number of forecasters predicts higher rates next month. The central bank will announce its decision on rates at 12 p.m. today, following a meeting of the nine-member Monetary Policy Committee that started yesterday. The minutes of the meeting will be published on Jan. 24. The implied rate on the interest-rate contract maturing in March was 5.51 percent yesterday, up from 5.32 percent on Dec. 1. The contract settles to the three-month London inter-bank offered rate for the pound, which averaged about 15 basis points more than the central bank benchmark rate for the past decade.

The European Central Bank will probably leave its benchmark interest rate unchanged as President Jean-Claude Trichet waits for more evidence of accelerating inflation before raising borrowing costs.

The Australian dollar gained, the biggest fluctuation of any currency today, as a government report showed employment rose three times as much as economists forecast. The currency climbed the most in a week as the figures completed the best year of jobs growth since 1989, adding to signs the economy is expanding at a pace that may require higher borrowing costs.

LR

The U.S. trade deficit edged higher in November from a 14-month low as retailers stocked up on imported goods ahead of the holiday shopping season, economists said before a government report today. The gap between imports and exports widened by $1.1 billion in November to $60 billion. The deficit shrank in the two prior months as the price of imported petroleum dropped. Oil prices leveled off in November, keeping the deficit from narrowing further, while increased consumer spending continued to fuel demand for imports. Even so, the trade gap will remain in check in coming months because a weaker dollar and growing economies in Europe and Asia are boosting demand for U.S.-made goods.

The pound may fall against the euro, snapping a two-day winning run, after a survey showed confidence among U.K. consumers fell in December to match a two-year low. The pound has fallen against the euro for the last two months on speculation the U.K.'s interest-rate advantage over the euro region will narrow this year. The BOE last month kept its repurchase rate at 5 percent as the European Central Bank raised its benchmark for the sixth time in a year, to 3.5 percent. The pound rose against the euro and the dollar yesterday after a report showed revenue at U.K. stores open at least 12 months gained 2.5 percent last month from a year earlier, after rising 0.5 percent in November, the slowest pace in nine months, the British Retail Consortium said. Goldman Sachs Group Inc. this week revised its view for U.K. interest rates, forecasting the BOE will lift its benchmark rate to 5.25 percent in February, raising an earlier forecast the central bank would stay on hold at 5 percent. Interest-rate futures trading shows investors expect the BOE to lift rates once more by the end of the first quarter.

The yen may weaken as a Bank of Japan interest-rate increase next week won't be enough to deter investors from seeking bigger returns abroad. Raising rates to 0.5 percent will still leave Japan's borrowing costs at the cheapest among major economies, encouraging investors to use yen loans to purchase higher- yielding assets in so-called carry trades.

LR

Last night saw the release of the retail sales from the UK which showed annual growth of 4.4% compared to an expected 4% which is why sterling has strengthened against the Euro this morning.

We also saw sterling rebound against the dollar, regaining most of the loses it made on Friday, which is supporting a possible UK interest rate hike next month.

Later today we see data released from Germany, which is expected to show an expanding trade surplus which will bode well for GDP.

Have a good day.

DE

A Bloomberg survey of 40 economists suggests the pound will decline in 2007, with a slow down in expansion and lower inflation cited as the main reason. The pound fell 1.4 per cent last week against the dollar.

It is a quieter data week in the US this week. Fed Governor Kohn's speech today on the US economy will be closely watched. On the data front, US weekly jobless claims and December retail sales numbers will be of most interest.

Outside of the US, all eyes will be on the ECB press conference today. ECB President, Jean-Claude Trichet is expected to signal that Europe and Asia will be able to withstand a slowing U.S economy, reinforcing expectations of higher interest rates in those regions. Rate markets are fully pricing a rate hike in Q1.

The Yen is expected to become more volatile in the coming months as investors speculate on interest rate rises for only the second time in six years, with strong signs of expansion in the Japanese economy. On the back of this, the New Zealand dollar fell 3.7% at the end of last week, to a three week low against the yen on speculation that Japanese investors sold it for yen on the expectation of rate rises in Japan.

MA

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