Foreign Currency Report 13 February 2007

GBP
The Bank of England's quarterly inflation report released on Wednesday is expected to show January's increase in interest rates will not be the last. The inflation report will provide BoE's latest forecasts on growth and inflation. Official figures indicate that gross domestic product (GDP) and especially inflation are already running above the central bank's previous round of predictions in November. Data released last month showed the annual CPI rate jumped to 3.0 pct in December, taking the rate dangerously close to the 3.1 per cent mark, which, if it hits this level, would force BoE governor Mervyn King to write an explanatory letter to the Chancellor of Exchequer, Gordon Brown. Inflation is however this month expected to have held close to the 10 year high, at 2.9 per cent, following last month's 3 percent increase, the most since comparable records began in 1997.

Policymakers will have had early access to January's inflation data at their monthly meeting, a week before the numbers are made public. The BoE has been concerned that the higher cost of living might feed through to wage demands and spark yet more upward price pressures. But while there has been some evidence of a pick-up in wage deals, it probably wasn't enough to ring alarm bells. BoE Governor Mervyn King has said he expects inflation to drop quite sharply later this year and if January's data shows the rate subsiding, his prediction will gain weight.

EURO
Europe's expansion probably accelerated in the Q4, capping the best year for the economy since 2000 as the region's central bank prepares to raise interest rates.

The GDP of the nations that share the euro probably grew 0.6% in the Q4 from the third, when the economy expanded 0.5%, according to the median estimate of 39 analysts in a Bloomberg News survey. Eurostat, the European Union's statistics office, is due to publish the data at 11am in Luxembourg, along with a first estimate of 2006 growth.

Booming exports led companies to increase spending and hiring, propelling the economy to 2.6% growth for the year, according to an EU forecast. Faster Q4 expansion would suggest that figure may be revised higher. We're ending the year on a fairly strong note,' said Silvia Pepino, an economist at JPMorgan Chase & Co. in London, who estimates 2.7% expansion in 2006. The economy will probably lose a bit of momentum this year, but it will still be firm. The expansion will continue.' The European Central Bank signaled February 8 it's ready to raise its benchmark rate in March for the seventh time since December 2005 to keep inflation in check. Investors expect an increase in the rate to 3.75% from 3.5%, futures trading shows. The euro-region growth figures will be preceded by reports from member countries today.

France's economy probably expanded 0.5% in the Q4 from the third, when it stagnated, another survey of economists shows. Growth may also have accelerated in Italy and Spain. The German economy, Europe's largest, probably maintained its momentum in the Q4, growing 0.6% from the third, a separate survey shows. That report is due from the Federal Statistics Office in Wiesbaden at 8am today. German investor confidence may have risen for a third month in February, another survey shows. The ZEW Center for European Economic Research in Mannheim may say its index of investor and analyst expectations rose to 5 from minus 3.6 in January, according to the median estimate of 37 economists. That report is also due at 11am today. Overall, there is a bit more momentum building in the euro-area economy,' said Dominic White, an economist at ABN Amro in London. If that starts to spill over and you get a pickup in wages, then that's going to be pretty important for the ECB.' The Frankfurt-based central bank is concerned that the pace of economic growth will enable companies to raise prices and unions to push through demands for higher wages. Unemployment in the euro region declined to 7.5% in December, the lowest since records began in 1993, and confidence in the economy remained close to a six-year high last month. Economic growth may moderate this year after Germany and Italy raised taxes and as global demand for European exports started to cool. The ECB in December forecast growth will slow to about 2.2% this year from 2.7% last year. Its next set of economic projections is due in March.

USD
A number of key economic reports are due out later in the week. Wholesale inflation will be announced on Friday. Housing starts data will be released at the end of the week as well. Meanwhile, Wednesday will see the release of retail sales statistics. Also on Wednesday, Federal Reserve Chairman Ben Bernanke will begin 2days of testimony before Congress. In his testimony, which will conclude on Thursday, Bernanke will provide his outlook for the economy and interest rates

Questions about the strength of the economy and the direction of interest rates come to a head this week, when Federal Reserve Chairman Ben Bernanke hits Capitol Hill.

In a busy week for market watchers, reports are also due on the trade balance, retail sales, business inventories, housing and manufacturing, among other sectors of the economy.

In his semi-annual testimony before Congress the Senate on Wednesday, the House of Representatives on Thursday the Fed chief is expected to touch on a range of topics related to economic growth and pricing pressure, among other issues. "The focus of the testimony will be on disseminating the Fed's forecast for GDP growth and core inflation, and what that forecast implies for interest rates," said Joshua Shapiro, chief economist at Maria Fiorini Ramirez Inc.

Bernanke is not likely to tell the stock market what it would like to hear - that inflation is moderating faster than the central bank anticipated and that the next change in short-term interest rates will be a cut. But he's also unlikely to tell the market what it doesn't want to hear that inflation is not moderating fast enough and that the central bank will have to raise rates soon. What he is likely to do is put into context the recent hawkish commentary from a barrage of Fed officials as well as the spate of surprisingly strong economic news. "We're at a stage where the economy is growing at a reasonable pace and inflation is still higher than what the Fed wants," Shapiro said.
The testimony lets Bernanke "lay out a roadmap for investors," as to where the bankers see things going over the next six months.