Commodities, focus on CAD/JPY

Brent futures surged on Friday to a 32 mth low. This morning the front contract is trading a little below its high though it remains elevated. The continued strength of commodities is lending unabated support to the currencies such as the NZD, AUD, NOK and the CAD.

All of these currencies performed particularly well vs. the weak yen last week. While there are signs that many of the yen crosses have become over-extended, we see scope for further upside for these crosses vs. the yen medium-term.

CAD/JPY is likely to be in focus this week given tomorrow's BoC policy meeting. The Bank is expected to confirm steady policy. However, there is a risk that the BoC will lessen its dovish tone and start preparing for a rate hike potentially in July.

Last Friday's Canadian payrolls report brought confirmation of a whopping 90.6K increase in full-time jobs in March and a fall in the unemployment rate to 7.7%. The unemployment rate has been in steady decline since its peak in August 2009 and unlike in the US is positioned at a level which can be considered 'normal' in a historical context.

Also supportive for the CAD is its decent correlation with oil; the US imports more oil from Canada than any other single country. On the assumption that oil prices remain firm we look for the CAD to make further progress vs. both the USD and the JPY. We are targeting USD/CAD 0.93 medium-term and see the potential for CAD/JPY to push higher towards 0.97 on a 12 mth view.

GBP still vulnerable vs. the EUR

Arch hawk Andrew Sentance hinted heavily yesterday that he had voted for a 50 bps rate hike in last week's policy meeting. The minutes of the meeting will not be published until April 20, but any other vote from Sentance would be a surprise.

After all he has voted for a rate hike in every meeting since last summer and called for a 50 bps move in both February and March. Despite the hawkish remarks EUR/GBP has been biased higher this morning. While Sentance has largely lost his ability to shock the market, UK economic data have not.

This week's releases of CPI, labour and consumer confidence data will be instrumental in fine tuning market expectations as to when the BoE will first hike interest rates this cycle. First up will be tomorrow's inflation data. The market is expecting a headline rate of 4.4% y/y, in line with the February number.

However the BoE has warned that UK inflation could hit 5% y/y this year suggesting that there are upside risks to this release. A stronger number may support the pound, though we would not expect the impact to last. The 2007/08 depreciation in the pound and the rise in oil prices have been major contributors to the strength of UK inflation (see graph).

A third major factor has been the January VAT hike. Higher fuel, food and taxes have all been eroding consumers' disposable income. This month's round of austerity will deepen the wounds. This week's labour data release will probably show signs that more public sector jobs have been shed.

In this environment there is little risk that consumer confidence data due at the end of the week will be anything better than subdued. We expect that most of the MPC members will want to see the effects of this month's austerity before hiking interest rates and forecast steady BoE rates until November 2011. On this view sterling remains a sell on rallies vs. the EUR.

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