Key Points
ECB provides no fresh arguments for money market - downside risk on EUR-USD.
Cable should head lower if MPC leaves rates unchanged.
Asian equities shrug off weakness in Europe/US.
Surprise RBNZ rate hike boosts NZD, but such a move may advance problems for NZ economy.
Strong Australian labour market data cements case for July rate hike.

Market Outlook
The majors remain quiet, with the general global rise in interest rate expectations seemingly cancelling each other out in terms of arguments for respective currencies. Indeed, market focus is now on the impact such elevated rate expectations are having on global market sentiment (more below). From a positional perspective we would still see downside risk for EUR-USD and yesterday's ECB meeting offered few fresh pointers for already high rate hike expectations. Indeed, with ECB rates likely to be on hold until September, there is a risk that the ECB policy debate fades into the background a little, unless there are some very strong data surprises. Trigger level on EUR-USD is at 1.3475.

Cable has been holding firm ahead of today's MPC announcement and with the RBNZ springing a surprise overnight (see below for more) this may increase the sense of apprehension about the MPC outcome (see below for MPC preview). Unchanged rates should see cable falling back. Below 1.9900-10 would be a negative signal.

As noted above, markets are now watching how investor risk appetites develop in a higher interest rate environment. The weakness seen yesterday in European and US equity markets has not been supplemented in Asia, with most indices holding firm. Moreover, just as there have been doubts about global markets and risk appetite, the yield arguments in favour of certain high-yielding currencies like the NZD and the AUD have been advancing this week and there were further positive developments overnight.

A surprise 25bp rate hike from the RBNZ boosted the NZD. The move was an unusual one given that there has been little time to judge the effects of previous rate rises and suggests that the RBNZ has basically run out of patience, deciding to adopt a more heavy-handed approach to dealing with the household sector. Such shock treatment may well do the trick and this is perhaps the conundrum now facing the NZD. Quite clearly its high-yield credentials have been boosted further by this move, but the RBNZ may have also brought forward the day when the economy finally responds in negative fashion. When that happens, expectations and sentiment about rates and the NZD could change dramatically. In the short-term, the NZD probably has further to travel on the upside, but we would treat it with some caution.

The AUD has also been boosted overnight, this time by stronger than expected labour market data. In combination with most other data releases seen in recent weeks, the case for an immediate RBA tightening is now very high and expectations about a hike in July are likely to be firmed up in coming weeks. There is risk towards 0.8600 in the short-term and we still see the AUD outperforming the NZD.

Day Ahead
UK - the MPC are likely to leave rates unchanged and if that's the case there will of course be no statement. In the minutes of the last meeting, when discussing the possibility of a 50bp rather than a 25bp move, the following was noted. 'If the Committee had been reasonably confident about the need for another interest rate rise soon, then a strong case could have been made for an increase of 50 basis points this month.' In terms of data releases, not enough has happened since that last meeting to change their minds about the need for a further move in the very short-term. While the price expectations components of industry surveys remain at levels that will be of clear concern, the very latest PPI output data was weaker than expected and retail sales and mortgage approvals have also softened. The market has not been absolutely sure about the outcome of this meeting, so some slippage in GBP looks likely if rates are left unchanged.

Japan - tonight sees the release of bank lending, which has tailed off a little in recent months after the M&A related strength of Dec and Jan. Machinery orders are also due, having disappointed in recent months. The weakness in the orders data is not consistent with the capex strength of Q1.

Diary
Data/event BST Consensus*
NO Manu output (Apr) m/m 09.00 0.5%
GB MPC rate announcement 12.00 unch
US Initial claims (w/e Jun 2) 13.30 312k
US Continuing claims (w/e May 26) 13.30 2472k last
ZA SARB repo announcement 14.20 50bp
US Consumer credit (Apr) 20.00 $6.0bn
JP Machinery orders core (Apr) m/m 00.50 4.5%
JP M2 plus CDs (May) y/y 00.50 1.2%
JP Bank lending (May) y/y 00.50 1.0% last
AU Housing finance (Apr) m/m 02.30 2.0%
Latest data Actual Consensus*
NZ RBNZ rate announcement 25bp unch
AU Employment (May) 39.4k 11.3k
AU Unemployment rate (May) 4.2% 4.4%
CH Unemployment rate (May, sa) 2.8% 2.8%
GB HBOS house prices (May) m/m 0.3% 0.5%
* Consensus unless stated