Interest rate considerations have remained the dominant influence and the yield trends seen during the last week have prompted what could be a significant reversal in the currency markets.

The US consumer price increase for February was held to 0.1% at the headline and underlying levels with a core annual rate of 2.1%, unchanged from the January level. The US data as a whole had a mixed tone, with a strong reading for the New York manufacturing index offset by a weak Philadelphia survey. Housing starts and retail sales both fell sharply for February, but this followed the strong weather-related boost seen in January.

The data in terms of growth was still firm, but the inflation components were under control with weaker price indices in the manufacturing surveys and a slightly lower than expected industrial capacity use rate as well as a low consumer inflation figure. This pattern was repeated in the Federal Reserve’s Beige Book on economic conditions. The Fed districts reported solid growth, but also that there were no labour-cost pressures evident.

Fed Governor Yellen stated during the week that, although there were still inflation concerns, the Fed would need to be on its guard over the risk of tightening policy too far, especially as interest rate increases act with a delay. There was also a report from an influential consulting group that the Federal Reserve was unlikely to increase interest rates beyond the 5.0% level.

Although markets are still very confident over a March increase to 4.75%, these remarks sparked an adjustment in futures markets. Market expectations of a rate increase in May were lowered to around 70% from 90% while the chances of a June increase were priced out entirely.

In response, the dollar weakened sharply to lows around 1.22 against the Euro compared with the challenge on levels stronger than 1.19 seen after the firm US employment report last week. The dollar also lost ground on a trade-weighted basis with the record current account deficit for the fourth quarter of 2005 offering no support to the US currency.

Wide-ranging Euro gains were triggered in part by market rumours that the ECB would continue to increase interest rates until a neutral range of 3.0 - 4.0% was reached. Elsewhere in Europe, there were interest rate increases by the Swiss and Norwegian central banks while there were reports of central bank reserve diversification into the Euro.

The Japanese yen retained a firm tone over the week with gains to stronger than 116.0 against the US dollar on Friday. There was speculation over an early move by the Bank of Japan to increase interest rates while Japanese bond yields rose to a 5-year high during the week. There was also evidence of capital repatriation ahead of the fiscal year end.

Sterling was caught in the middle between dollar and Euro moves during the week. The UK data was mixed with a soft bias and failed to provide clear leadership or Sterling support. The labour-market data was a notable feature over the week with unemployment registering the biggest monthly increase since 1992 while earnings growth remained weak. The UK currency pushed back to the highest levels for four weeks against the dollar, but remained under pressure against the Euro.

High-yield currencies remained under pressure with the Australian and New Zealand dollars depreciating during the week. Both currencies fell against the dollar with the Australian dollar dropping below 0.73 support even though the US currency was generally under pressure at the same time.

Have a great day and a wonderful week.