The dollar fell versus most key currencies in NY trading Friday pressured by diminished Fed rate hike expectations as US equities declined to a 3-month low and crude oil prices rebounded on a report Israel may strike Iranian nuclear facilities. The yen strengthened on increased risk aversion as US stocks tested important support. The euro was supported by ECB members' hawkish rhetoric while the Fed is thought to focus more on the weak US economy rather than the threat of rising inflation and keep the benchmark rate unchanged at the FOMC rate decision meeting next Wednesday.

The USD/CAD rose modestly for the first time this week despite Canadian April retail sales gains. Bank of Canada Governor Mark Carney said last night that inflation risks in Canada are "now judged to be evenly balanced," adding that BOC policy makers won't be "complacent" as inflation accelerates. The USD/CAD has been in a narrow trading band this year. We expect the pair to continue trading in this range.

Financial and Economic News and Comments

US & Canada

Canadian retail sales rose for the fifth time in seven months in April, increasing 0.6% m/m to C$35.6 billion ($35 billion), on clothes and gasoline, Statistics Canada reported, revising March's 0.1% increase to unchanged. The April gain indicates Canadian consumer spending remains relatively buoyant despite slowing economic growth.

Bank of Canada Governor Mark Carney said the BOC won't be "complacent" as inflation accelerates. "In the face of the largest commodity-price shock in our lifetimes, we cannot be complacent," Carney said. "The situation wasn't ideal but the bottom line is we are going to take the right decision" to control inflation. The key interest rate is "appropriate,'' he said.

The International Monetary Fund said the US economic slump has been shallower than forecast, warning the Federal Reserve may have to raise interest rates "quickly" to contain inflation. The IMF said US economic growth will be "roughly flat" in 2008 and raised the US 2009 growth forecast to 2% from 1.6%. "The slowdown in the U.S. has been less than feared, and a recovery should begin next year as important headwinds are overcome," the IMF said. "A more rapid recovery is clearly possible given the substantial policy stimulus and proactive response of financial markets to repair balance sheets."

Europe

Germany's producer-price inflation accelerated 6.0% y/y in May, the most since July 2006, and increased 1.1% m/m, in both cases more than expected, on record energy costs, data from the Federal Statistics Office showed. Energy prices rose 15.0% y/y. Excluding energy, the PPI rose 2.9% y/y and 0.4% m/m. European Central Bank President Jean-Claude Trichet on June 5 said the ECB may raise its benchmark interest rate in July to rein in inflation expectations. With euro-zone inflation showing no sign of abating, markets are now anticipating ECB rate hikes at least twice before the end of the year.

ECB Executive Board member J?rgen Stark said euro-zone inflation is "unacceptably high" and the ECB is ready to take whatever action is necessary to ensure price stability. "The current annual inflation rate in the euro zone of 3.7 percent in May is unacceptably high, and inflation is likely to remain high for a prolonged period before gradually declining again," Stark said. "'We will do everything necessary to ensure that inflation expectations remain firmly anchored and secure price stability in the medium term," he said.

Asia-Pacific

Convenience stores sales in Japan rose 3.7% y/y to ?600.6 billion in May, up for the first time in three months and the biggest rise in four years, due to a surge in cigarette sales in stores, after falling 0.2% y/y in April, the Japan Franchise Association said.

People's Bank of China Governor Zhou Xiaochuan said the PBC may formulate "stronger policies" to tackle inflation exacerbated by the government's fuel-price rises. "Surely higher energy prices will send some pressure to the consumer price index, so we may have stronger policies against inflation," Zhou said.

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