The US data flow was slower this week and the releases also failed to have major market impact. Headline consumer prices rose 0.7% in January as food and energy prices rose sharply, but the core increase was held to 0.2% with the annual increase falling slightly to 2.1% from 2.2%.

Jobless claims fell to 278,000 in the latest week, indicating further strength in the labor market, while durable goods orders fell sharply by 10.2% in January as there was a slump in the volatile aircraft sector.

The minutes from the January Federal Reserve meeting recorded a unanimous vote for a 0.25% increase and failed to change market expectations. The Fed was still on inflation alert given potential capacity constraints, but confident that interest rates were close to the correct level. Futures markets changed little over the week, still pricing in at least a 70% chance of a further 0.25% rate increase at each of the next two Fed meetings which would take the fed funds target to 5.0%. The Euro-zone data remained strong with a rise in the German IFO index to 103.3 for February, the strongest reading since 1991.

The data reinforced confidence in the German economy, while ECB Chairman Trichet came as close as was possible to pledging a further 0.25% Euro interest rate increase in March. The Euro was unable to sustain a move above 1.1950 against the dollar and was holding close to 1.19 on Friday.

The dollar found itself overshadowed by yen movements over the second half of the week, especially with a lack of major US data releases, and there was a much greater focus on Japan as yen volatility increased.

Japanese monetary policy remained an important focus during the week with persistent speculation that the Bank of Japan was moving close to a policy tightening. The domestic data remained firm and the trade data indicated firm exports even though there was a headline trade deficit. The speculation over a tightening was reinforced by parliamentary testimony from Bank of Japan governor Fukui on Thursday and Friday as he indicated that the bank was preparing to tighten policy. The yen suffered further tests of support close to 119.0 against the dollar early in the week, but there was a sharp reversal over the second half and the Japanese currency strengthened sharply to lows below 116.50 on Friday.

The speculation over a Japanese tightening contributed to substantial position adjustment with a sharp reduction in carry trades funded through the yen. The pressure to buy-back short yen positions was enhanced in mid-week by stresses in emerging markets. The Icelandic currency was subjected to heavy selling pressure after a credit downgrade from Fitch, with losses exceeding 10% over a 48 hour period as short-term funds exited the market. The Icelandic losses also unsettled other emerging-market currencies.

These losses forced a cutting of long positions funded through the Euro and yen, helping to trigger a sharp New Zealand dollar drop to below 0.66 against the dollar before a slight recovery. The overall damage to high-yield currencies as a whole was measured with no evidence of systemic losses.

The UK data failed to have a major impact, but the Bank of England minutes were potentially significant. There was a 8-1 vote for unchanged rates in February and, with markets expecting a bigger minority vote for a rate reduction, there was an adjustment to interest rate expectations which underpinned Sterling.

The UK currency recovered to levels above 1.75 against the dollar. The UK currency also gained further support from investment flows and pushed to 0.68 against the Euro even with confidence over further ECB rate increases.