• The dollar rose against most key currencies on Tuesday after Federal Reserve Bank of Cleveland President Sandra Pianalto warned of the risk of inflation and US retail sales excluding autos rose more than expected, increasing speculation the Fed will stop lowering interest rates. The greenback extended gains after Federal Reserve Bank of Kansas City President Thomas Hoenig said inflation has increased to levels that are unacceptable. The yen and Swiss franc fell on increased carry-trade demand. The Canadian dollar strengthened as the crude price surged to a new high.
• Unable to rise above the 1.96 handle resistance, the GBP/USD fell despite stronger-than-expected UK consumer price inflation. The pair is at the lowest level since February on speculation the Bank of England will cut rates further as the UK economy slows. Slowing growth and rising inflation create a dilemma for the BOE; nevertheless, we believe the BOE will lower rates further. The BOEs inflation report tomorrow is likely to highlight the dilemma. The GBP/USD will fall further as both growth and interest rate differentials deteriorate. There are short-term support at the 1.94-handle and resistance in the 1.96-area.

Financial and Economic News and Comments

US & Canada

• US import prices soared for a second-straight month in April jumping a more-than-forecast 1.8% m/m, compared to an upwardly revised 2.9% m/m increase in March, the Labor Department said. April import prices increased 15.4% y/y, the largest annual rise since the data began in September 1982. April petroleum import prices rose 4.4% m/m and 57.2% y/y. Natural gas prices jumped 30% y/y. Excluding petroleum, import prices increased 1.1% m/m and 6.2% y/y, the highest since 1988. Overall April data suggest import prices remain an inflation risk to the US economy.

• US retail sales narrowly fell 0.2% m/m in April, matching consensus expectations, due to a decline in the automobile industry, after increasing 0.2% m/m in March, data from the Commerce Department showed. US sales of automobiles and parts fell 2.8% m/m in April after dropping 0.5% m/m in March. April retail sales excluding autos rose a more-than-forecast 0.5% m/m after an upwardly 0.4% m/m increase in March, indicating consumers were out buying things, good news for the sluggish economy.

• US business inventories increased 0.1% m/m to a seasonally adjusted $1.465 trillion in March, less than anticipated as sales rebounded, following a downwardly revised 0.5% m/m rise in February, the Commerce Department said. Business sales increased 1.0% m/m to $1.154 trillion in March after a revised 1.0% m/m decline in February. March inventory-to-sales ratio slightly lowered to 1.27, from 1.28 in February. Inventories rose 5.2% y/y and sales climbed 6.3% y/y.

• The Federal Reserves recent liquidity measures have led to improved market conditions including a narrowing of credit spreads and better performance of repurchase agreement markets, Fed Chairman Ben S. Bernanke said in prepared remarks to the Atlanta Feds annual conference in Sea Island, Georgia. However, Bernanke warned that "conditions in financial markets are still far from normal" and pledged to increase the size of the Feds term auction facility if required.

• Federal Reserve Bank of Cleveland President Sandra Pianalto said in a speech in Paris that US consumer prices are rising faster than she would like and that inflation is a "key risk" to the economic outlook.

• Federal Reserve Bank of Kansas City President Thomas Hoenig said central bankers face a "major challenge" in containing inflation as the economy expands later this year.

Europe

• UK consumer price inflation accelerated at its sharpest pace in almost six years in April. The UK consumer price index rose a higher-than-expected 3.0% y/y, well above the Bank of Englands 2.0% target and within a whisker of the level that would require the BOE to write an explanatory letter to the UK government, after rising 2.5% y/y, data from the Office for National Statistics showed. The CPI rose a more-than-forecast 0.8% m/m in April, following a 0.4% m/m increase in March. The April core CPI rose 0.5% m/m and 1.4% y/y, after gaining 0.4% m/m and 1.2% y/y in March.

• The UK retail price index rose to a more-than-forecast 4.2% y/y in April, a 5-month high, after rising 3.8% y/y in March, the Office for National Statistics said. The RPI rose a more-than-expected 0.9% m/m in April,

  following a 0.3% m/m increase in March.

• Sentiment in the housing market in England and Wales fell to its lowest level in more than 30 years in April. According to the latest housing market survey by the Royal Institution of Chartered Surveyors, more surveyors reported falling rather than rising house prices in April, with the net balance dropping to -95.1 percentage points, the lowest level since the series started in January 1978, from a revised -79.4 percentage points in March.

Asia-Pacific

• Chinas retail sales rose 22% to a record 814.2 billion yuan ($116 billion) in April, the fastest pace since at least 1999, after gaining 21.5% in March, the statistics bureau said. The increase signals domestic consumption may help buffer the Chinese economy against an export slowdown.

• Australian Treasurer Wayne Swan forecast a record surplus in a budget that will reduce benefits to highincome earners to help the Reserve Bank of Australia fight inflation.

FX Strategy Update