EUR/USD surged sharply higher last week and breached 1.4 level as markets' rate speculations was further affirmed by ECB President Trichet's hawkish messages. While the ECB left the main refinancing rate unchanged at 1%, Trichet signaled an 'increase of interest rates in the next meeting is possible' and 'strong vigilance is warranted'.

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Also, the reference that interest rates are 'appropriate' was taken out from the press statement. The ECB staff revised up forecasts for economic growth and inflation. Annual real GDP will expand in a range between 1.3-2.1% in 2011 and between 0.8%- 2.8% in 2012. The lower ends of the ranges have been lifted when compared with December's estimates. As a result of 'considerable rise in energy and food prices', the ECB also revised up its inflation forecasts. Annual HICP inflation will probably grow in a range between 2-2.6% for 2011 and between 1-2.4% for 2012. More in Trichet Signals Tightening Begin Next Month.

The signal for an April hike was also supported by other ECB officials. France Noyer said that some question marks start to arise that some pressure for second-round effects develops, that some pass-through is being seen, and We need to reaffirm very strongly that we will never let that happen. ECB Executive Board member Bini Smaghi warned that failure to lift borrowing costs in response to faster headline inflation would make the monetary policy stance more accommodative and over time fuel core inflation. Gonzalez-Paramo said the risks to inflation are on the upside and it is the mission of the ECB to prevent those from materializing. Cyprus Orphanides said central banks must be pre-emptive in fighting inflation. Meanwhile, German Chancellor Merkel said that irrespective of the questions of the ECB and interest rates, we know that we have to put a joint package for the euro on the table to take the debt crisis. Luxembourg Prime Minister Jean- Claude Juncker also said that has nothing to do with the question of interest rates.

On the other hand, dollar failed to ride on positive economic data and was sold off against European majors. Both ISM manufacturing and non-manufacturing indices rose to 7-year highs in February. US' employment data have improved further. Non -farm payrolls unexpectedly added 192K in February while January's reading was revised up to +63K. Unemployment rate surprisingly slipped to 8.9% in February from 9% in the prior month. Bernanke downplayed the significance of recent jump in oil prices, signaled he would keep QE2 until expiry in June and refused to rule out the possibility of further QE measures. Bernanke said recent recent surge in commodity prices not yet pose a significant risk and oil prices alone would probably not be enough to make us respond.

In additional, the greenback was pressured by the surge in commodity prices as gold made new record high while oil jumped to as high as 104.94, a level not seen since September 2008. Geopolitical tensions in the Middle East and North Africa remained the main driving force in crude oil's rally. Ease in concerns over oil supply disruption was short-lived as Libyan rebels rejected the peace deal offered by Venezuela. It's reported that protesters have moved westward and threatened to damage the central oil port of Ras Lanuf. Oil prices surged on worries that the unrest will spread to other oil-rich countries.

Elsewhere, Sterling's rally against dollar halted on pressured in cross selling against Euro and markets are now expecting ECB to hike earlier than BoE. Swiss franc was helped by risk aversion and comments from SNB Jordan that low interest rate level is not sustainable in the medium and long term. Canadian dollar managed to ride on strength in oil prices and after BoC delivered a more hawkish tone in March than previously despite no change in the policy rate. (more in BOC Sees Faster Growth, CAD Retreats on Profit-Taking). Australia dollar failed to strength in spite of strength in Gold. RBA kept the cash rate unchanged at 4.75% and delivered a neutral tone as policymakers see balanced risks to growth and inflation outlook. Also, for the first time in the current tightening cycle, the RBA stated that the current stance of monetary policy is 'mildly restrictive'. (More in RBA On Hold, Sees Only Moderate Inflationary Pressure). New Zealand dollar was the weakest currency as markets are expecting a rate cut from RBNZ this week.

Technical Highlights

The break of 76.88 support last week indicates that dollar index's down trend has resumed. The index is held well below the falling 55 days EMA, which affirms the bearish outlook. Daily MACD is also stayed below signal line and was falling, which suggests accelerating downside momentum. In any case, near term outlook will remain bearish as long as 76.88 support turned resistance holds and current fall would now be target a test on 75.63 low.

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In the bigger picture, weekly MACD in dollar index is also staying below signal line for a few weeks and is falling, which also suggest increase downside momentum in medium term. Whole decline from 88.70 is possibly resuming too and a break of 75.63 will likely send the index through 74.19 towards 61.8% projection of 88.70 to 75.63 from 81.13 at 73.23.

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The Week Ahead

Two central banks will meet this week. RBNZ is widely expected to cut rates to avoid going back into recession after the worst earthquake in 80 years. BoE on the other hand, is expected to keep rates and the asset purchase program unchanged. On the data front, main focus will be on Australia and Canada employment as well as US retail sales. In addition, EU leaders will meet on Friday to hammer out the highly anticipated comprehensive package of measures to tackle the region's debt crisis, which is expected to be signed off on March 25.

  • Monday: Canada building permits
  • Tuesday: UK RICS house price balance; German factory orders; Canada housing starts
  • Wednesday: Australia home loans; Swiss CPI; UK trade balance; German industrial production; Canada new housing price index; RBNZ rate decision
  • Thursday: Japan GDP final; Australia employment; UK industrial and manufacturing production, BoE rate decision; US jobless claims
  • Friday: China CPI; UK PPI; Canada employment; US retail sales, consumer sentiment

EUR/USD Weekly Outlook

EUR/USD's rally resumed after brief consolidations and reached as high as 1.4005 last week. Initial bias remains on the upside this week for 61.8% projection of 1.2873 to 1.3860 from 1.3427 at 1.4037. Break there will extend the whole rise from 1.2873 towards 1.4281 key resistance next. On the downside, below 1.3832 minor support will turn bias neutral and bring retreat. Nevertheless, near term outlook will remain bullish as long as 1.3427 support holds.

In the bigger picture, as long as 1.3427 support holds, we'd favor the case that rise from 1.2873 is extending rebound from 1.1875. Also, that would mean that we're favoring the case that medium term correction 1.6039 was completed with three waves down to 1.1875 and the long term up trend might be resuming. Break of 1.4281 resistance will further affirm this case and target 1.5143 resistance and then 1.6039 high.

In the long term picture, considering the five wave impulsive structure of the long term up trend from 2000 low of 0.8223 to 2008 high of 1.6039, price actions from 1.6039 are viewed as a correction only. Hence, firstly, we'd expect strong support between 61.8% retracement of 0.8223 to 1.6039 at 1.1209 and 1.1639 to contain downside. Secondly, we'd expect another high above 1.6039 eventually, after correction from 1.6039 is confirmed to be finished.

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