FOREX: Euro to Extend Gains as Rate Hike Bets Hit One-Year High

Overnight Headlines

• New Zealand Dollar Gains Despite Dovish RBNZ Rhetoric
• Australian Dollar Slumps as PM Unveils Flood Relief Levy
• Japan’s Trade Surplus Swells as Export Growth Picks Up

Critical Levels

The Euro was effectively flat in overnight trade, oscillating in a tight range around the 1.37 level to the US Dollar. The British Pound edged narrowly higher, adding 0.1 percent against the greenback.

Asia Session: What Happened

The New Zealand Dollar rallied despite apparently dovish commentary from the Reserve Bank of New Zealand, adding as much as 0.8 percent on average against its top counterparts immediately following the central bank’s monetary policy announcement. The RBNZ opted to keep benchmark borrowing costs unchanged at 3 percent as expected, with Governor Alan Bollard saying “underlying inflation remains comfortably inside the target band” and promising to “keep [rates] low until the recovery becomes more robust and [prices] show more obvious signs of increasing.”Traders’ optimism seems to have been centered on Bollard’s assertion that “forward indicators have firmed” while confidence has picked up “across a range of industries” and housing market activity has shown tentative signs of stabilizing.

The Australian Dollar underperformed after Prime Minister Julia Gillard unveiled a one-off levy to pay for flood reconstruction efforts. Gillard said the recovery will cost A$5.6 billion and shave 0.5 percentage points off economic growth this year. Economists polled by Bloomberg put the price tag at a far more significant A$20 billion. The Aussie fell as much as much as 0.5 percent on average against major currencies.

Japan’s Merchandise Trade Balance widened to 727.7 billion yen in December as export growth accelerated for a second month. Overseas sales added 13 percent from the previous year, topping expectations for a 9.3 percent increase and amounting to the fastest growth rate in three months. A slowdown in imports also helped push the headline figure higher, with inbound shipments adding 10.6 percent on an annualized basis.

Euro Session: What to Expect

Germany’s Consumer Price Index figures headline the economic calendar, with preliminary estimates expected to show that the annual inflation rate ticked up to 2 percent in January. As we suspected earlier this week, the outlook for monetary policy has taken a more prominent role in driving Euro price action, with the correlation between EURUSD and the 2-year Treasury yield spread rising to the highest in over three weeks. This hints the single currency is likely to advance as firming inflation figures in the Euro Zone’s top economy put upward pressure on rate hike expectations.

This seems all the more likely after ECB President Jean-Claude Trichet changed his tune toward a more hawkish posture once again today, saying he was prepared to “do what is necessary” to deliver price stability at the World Economic Forum in Davos. Trichet had conspicuously back-tracked from similar sentiments just three days ago. A Credit Suisse gauge of priced-in ECB rate hike expectations has surged to the highest in close to a year, showing policymakers will add 85.7 basis points (meaning between 3-4 rate hikes) to borrowing costs over the next 12 months.

US economic data will be in focus later in the session, with Durable Goods Orders set to rebound in December to add 1.5 percent, snapping two consecutive months of losses, while Pending Home Sales rise for the third month (albeit at a slower pace). Weekly Jobless Claims figures are also on tap.

For real time news and analysis, please visit http://www.dailyfx.com/real_time_news

To receive future articles by email, please contact Ilya at ispivak@dailyfx.com