The initial boost to risk appetite on the news of the demise of Bin Laden quickly petered out as the market concluded that it would be naive to assume that the threat of terrorism had died alongside him. EUR/USD remains close to level traded ahead of the UK's long weekend with relative growth and interest rate differentials remaining the dominant focus.

Various members of the ECB Council have been making the point over the past few weeks that the ECB is not pre-committed to a series of interest rate hikes. However, that does not mean that the ECB will not hike interest rates further this year if it views inflationary risks as sufficiently strong. We now see a June rate hike as likely and if that is correct it can be assumed that Trichet will provide a signal to the market at this week's policy meeting. The EUR is likely to react positively to any hawkish signal from the ECB on Thursday suggesting that, despite the softer tone in the EUR this morning, EUR/USD has the potential to edge back towards the 1.4900 level this week. While Friday's payrolls data is a big focus for the USD, the clear indication from the Fed at last week's FOMC meeting that it is no hurry to hike rates should sap the ability of even a strong report to significantly renew buying momentum in the USD. Comments yesterday from the Eurogroup's Juncker that EUR strength is not giving rise to concern and is more a reflection of the weakness of the dollar appear to give a green light to further appreciation of EUR/USD. These remarks reflect the relatively measured appreciation of the Eurozone's effective exchange rate this year (see graph). While the effective exchange rate has been appreciating in 2011 it has only recovered about half the losses made in the run up to the Greece crisis a year ago and remains significantly below the highs of 2008 and 2009. In view of the perceived inflationary threat the ECB has no incentive to talk the EUR lower, though stable conditions will continue to be favoured. We would look to buy EUR/USD on dips on anticipation of a break through 1.50 later this year. Today, Eurozone PPI data and US factory orders data will be of interest.

AUD/CAD

Ahead of the federal election Canadian fundamentals already looked relatively strong. Now that the conservative government has a decisive majority the backdrop should be even more favoured by markets. The CAD reacted positively to the election result with AUD/CAD falling noticeably as sentiment in the AUD was hit by a less hawkish than expected tone from the RBA overnight. While we expect that the CAD will continue to edge higher vs. the broadly weak USD, the reluctance of the BoC to signal a need to tighten policy suggests that further downside in AUD/CAD is likely limited near-term. That said a strong Canadian jobs report on Friday could invigorate speculation of a July rate hike which would lend additional support to the CAD on the crosses.

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