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The U.S. dollar continues to consolidate after sharp swings in the second half of last week and ahead of the testimony of Federal Reserve Chairman Bernanke starting tomorrow. There are, though, a few developments to note. The first is the Australian dollar, which has gained a full cent against the U.S. dollar on the back of short-covering in response to slightly less dovish RBA minutes. The Australian dollar has depreciated by about 15% against the greenback from mid-April through last week, when it briefly and shallowly dipped below $0.9000.

Last week, the Aussie did not respond as strongly as the other currencies to what were perceived as dovish comments from Bernanke and the gains it did score were quickly unwound with new cyclical lows before the weekend. The minutes showed that the decline in the currency raised some concern about inflation prospects. This in turn, saw the odds of the rate cut in early August, reflected in the OIS market, slip back to around 50% from 60%. The Aussie has trended higher and is trying to establish a foothold above $0.9200 near midday in London. Support is seen near $0.9150 now.

The Bernanke-induced high is another cent higher and given market positioning, a push toward there seems likely. A close of the North American session above $0.9180, the 20-day moving average, which it has not managed to convincingly do in 3 months, would confirm the improved technical tone within the context of bullish divergence in RSI and MACDs. The minutes underscore the importance of next week's CPI figures.

Some sterling sales for Aussie were reported following the 0.2% decline in the headline CPI. The consensus had called for a 0.1% decline. However, the year-over-year rate ticked up to 2.9% from 2.7% in May and is the highest since April last year. Nevertheless, many saw the report as supportive of QE and U.K. interest rates fell in response. The implied yield on the short sterling futures strip is off 3-7 bp through next year, while 10-year gilt yields are about 4 bp lower.

We note producer prices were firm as well. Input prices rose 0.2% for a 4.2% year-over-year pace. This compares with a 0.6% decline in May and a 1.8% year-over-year rate. Output prices were more subdued and this speaks to margins, especially at the core level. Core output prices were flat and up 1% year-over-year. Both the CPI and PPI data picked up the higher fuel prices.

The third development was the German ZEW survey. Although the current sentiment reading rose to 10.6 form 8.6 (consensus 9.0), the market initially paid more attention to the unexpected weak sentiment reading. IT fell to 36.3 from 38.5 in June (consensus 40.0). The recent data stream for Germany has been mostly disappointing. Recall the manufacturing PMI slipped in June to 48.6 and has not been above the 50 boom/bust level since February. Factory orders and industrial production contracted in May.

The euro slipped to make new lows for the European session in response to the ZEW survey near $1.3050, but quickly rebounded. The tone, as we anticipated, remains one of consolidation. We note that the five day average is moving above the 20-day average today for the first time in almost a month. The $1.3100 area capped upticks ahead of the weekend, and if this is convincingly taken out, the Bernanke-induced high near $1.3200 would be the next immediate target.

We draw your attention to two other developments, which arguably are more significant for local markets. First, the New Zealand dollar is benefiting from the general consolidative tone, but indications from the central bank make a rate hike less likely. It appears to be more likely to rely on macro-prudential policies to prevent a credit bubble. Specifically, it has signaled that it will soon announce restrictions on bank exposure to high loan-to-value mortgages (talk is of a cap at 12% of total lending) and may not grant exemptions for first time home buyers. Note that the RBNZ meets next week and was not expected to raise rates but there were some expectations of higher rates for later this year or early next.

Second, India's central bank tightened monetary conditions but stopped short of hiking the repo rate (7.25%). Instead, it raised the ceiling of its rate corridor by 200 bp to 10.25% and withdrew INR120 bln of liquidity from the money markets. The bank rate was also raised by the same amount to 10.25%. This is a way to support the currency without draining more reserves. The initial market reaction was to send the rupee to new two-week levels. The central bank also indicated that it will also move to cap the amount commercial banks can borrow from the repo window to around INR750 bln (where they have averaged INR872 bln a day this year).

These measures raised the cost of being short INR. However, there is a limit to the central bank's strategy. The same elevated interest rates that lend support to the currency threaten to further undermine the already weakening economy.

The U.S. reports June consumer prices and industrial output and May TIC flows. On balance, barring a significant surprise, the data are not likely to have much impact on the market, where Bernanke's testimony tomorrow is seen as key.

Source: Consolidative Tone Persists, Though Aussie Finds Legs