This is article is released weekdays under the heading Daily Fundamentals at 5pm EST on www.dailyfx.com

The New Zealand Dollar surged as a better-than-expected third quarter inflation report stoked expectations that interest rates will rise ahead of schedule but the central bank's recent actions hint that may not be the case. Euro Zone CPI and the ECB Monthly Report are on tap ahead.

Key Overnight Developments

• New Zealand Dollar Surges as CPI Outperforms, Manufacturing Sector Expands
• Japan: BOJ Upgrades Economic Outlook, Fujii Hints No Yen Intervention Ahead


Critical Levels

101509

The Euro and the British Pound continued to trend higher in overnight trading, adding 0.3% and 0.8% respectively against the US Dollar. The MSCI Asia Pacific regional equities benchmark index rose close to 1% ahead of the opening bell in London, sapping demand for the safety-correlated greenback. We remain short GBPUSD at 1.6617.

Asia Session Highlights

The New Zealand Dollar pushed sharply higher as third-quarter Consumer Price Index data showed the annual inflation rate had registered at 1.7%, a reading far higher than the expected 1.1% result. On a quarterly basis, prices grew 1.3% from the three months through March, the most in a year. The outcome fed expectations that the central bank will need to raise interest rates sooner than the latter part of 2010 estimate that RBNZ Governor Alan Bollard offered at the last policy meeting in September, pushing up a Credit Suisse index of traders' 12-month yield expectations by 9 basis points (5.84%) and driving buying interest in the antipodean currency.

This catalyst may not prove lasting however, considering the policymakers will be wary of acting on rates to protect the still very fragile export sector. Indeed, both the central bank and government have been very vocal about the detrimental effects of a higher Kiwi dollar in driving away foreign demand. Overseas sales make up over 30% of the economy's total output, so any policies that stand to hurt firms catering to foreign markets stands to stunt the fledgling economic recovery of recent months. In fact, the RBNZ may have already embarked on a somewhat covert tightening campaign aimed at checking inflationary pressure while minimizing the impact on the NZD exchange rate. The central bank leaked an announcement that it would end some of its emergency lending programs enacted amid the credit crunch in November, a fact that it did not officially confirm via an official news release until about a day later. This move will gradually slow the flow of liquidity into the economy, reducing the pace of money supply growth and acting against inflation. Policymakers' approach to the announcement suggests they were consciously trying to avoid a snow-ball effect that would send the New Zealand Dollar steeply higher. It also hints that perhaps this approach to tightening will be seen as sufficient to stick with rates at current levels until the second half of next year as scheduled.

Separately, Business NZ PMI rose to 51.7 in September, rising above the 50 boom-bust level to show that the manufacturing sector expanded for the first time since April 2008. The details of the report were broadly encouraging: a gauge of new orders led the metric higher, adding 5.6% from the previous month, while inventories were drawn down -4.4%, hinting that firms' output plans may have underestimated the rebound in demand.

The Bank of Japan's Monthly Report saw the central bank upgrade its economic outlook for the second consecutive month, saying the drop in capital spending is moderating while the pace of deflation is likely to stabilize in the short term. However, the more interesting news came from Finance Minister Hirohisa Fujii, who revealed that he told his US counterpart Tim Geithner that while he agrees with a strong US Dollar policy, nations should not compete to devalue currencies, citing the 1930s' FX devaluation as detrimental to the global economy at the last G7 conference. The comments hint that perhaps Japanese authorities will shy away from intervention if the Yen counties higher with USDJPY poised to sink deeper below 90.00, a level that was widely believed to be the threshold of Japan's comfort zone.


Euro Session: What to Expect

The Euro Zone Consumer Price Index report is set to confirm initial estimates to show that prices shrank at an annual pace of -0.3% in September. Analogous figures from Germany and France both disappointed, leaving the door open for a downside surprise this time around as well. While the data may not move the Euro as the single currency continues to benefit as the next-best alternative amid broad-based US Dollar weakness, the outcome will be significant for the broader trend especially considering that it will cross the wires just after the European Central Bank publishes October's monthly report. Traders will be looking for the ECB report to feature specific language about the level of the Euro, as its absence in last week's rate decision encouraged the markets to test policymakers' resolve with a swift run towards the 1.50 mark against the US Dollar. ECB President Jean-Claude Trichet are surely feeling the heat at this point as the surging currency pressures the export sector and threatens the tentative stabilization in economic growth over recent months, hinting that a more direct clarification on their preference for a weaker Euro is plausible. This may prove to weigh heavily on interest rate expectations, saddling the single currency with substantial (if not immediate) selling pressure.


For streaming currency market news and analysis, please visit
http://forexstream.dailyfx.com


To reach Ilya regarding this article or subscribe to his email distribution list, please contact him at ispivak@dailyfx.com