The dollar traded higher against the yen and was stable against the euro in overnight trading. USDJPY traded up to a high of 108.29 from a low of 107.92, while EURUSD traded in a 1.5554 to 1.5624 range. Equity markets finished lower on Monday, with the S&P 500 down by 0.9%, while both 2-year and 10-year Treasury yields rose 3 bps to 2.53% and 3.96%, respectively. Oil prices fell $3.69 to $121.41/bbl. Personal income for June rose by +0.1% m/m vs the +1.8% (prev. 1.9%) increase in May, alongside an increase in personal spending of +0.6% m/m vs +0.8% m/m in May. The core PCE rose by 0.3% m/m and 2.4% y/y - a rate likely too fast for the Fed's comfort. However, with increasing economic slack, our economists expect core inflation to slower later this year. Key events this week are the FOMC decision later today and the ECB meeting on Thursday. As for the FOMC, we expect a less hawkish statement than on June 25, with its tone consistent with the one struck by Chairman Bernanke in his semi-annual Monetary Policy Report testimony on July 15 and 16. In contrast, the ECB's outlook has and remains far from certain, with economic deterioration over the past month probably exceeding the Governing Council's expectations. Newswire reports from last week have already hinted that easing is in the offing as soon as the ECB can confirm that inflation expectations have peaked. It will be important to see if Trichet confirms this opinion during Thursday's press conference. Meanwhile, yesterday's Eurozone PPI release highlights that input inflation is still running high; cost pressures remain a concern for the ECB in spite of rapidly deteriorating activity indicators. We believe that the dollar can continue to head higher as rate spreads move in its favour, while slowing global growth will also dent asset allocation flows away from the US, and perhaps also encourage repatriation. But clear signals of rate cuts from central banks, especially the ECB, will be needed before the dollar can embark on a material move higher. Ahead today, the FOMC decision is due at 1815 GMT. The non-manufacturing ISM for July is due at 1400 GMT.

The headline reading of the Swiss PMI declined to an above consensus 54.1 in July. As such the Swiss PMI reached the lowest reading since August '05. While dropping below the long-term average of this time series after the longest phase ever with headline readings above the long-term average - 34 months to be precise - the headline reading remained solidly above the critical boom-bust line for another month in July. Final July manufacturing PMIs were released for Italy, France, Germany and the Eurozone. Only German PMI managed to satisfy expectations, showing a slight expansion of 50.9. All other results showed contractions and disappointed expectations. Ahead of Thursday's decision, services PMI results for July will be released across the Eurozone, and the zone-wide figure, in addition to non-Germany country numbers are expected to show a contraction. The trade balance for Germany will also be released this week and could point to further problems in global demand. The recent trade numbers out of Japan showed falls in exports to the Eurozone, the US and a slowing in export growth to Asia. The high value-added, capital-intensive nature of German exports are similar to Japan's mix and a disappointing German number would confirm that global growth is heading for further deterioration. This week's ECB decision may reveal a new bias for the Governing Council and the market will be looking for signals of easing as inflation expectations peak. Over the weekend ECB's Solbes said he saw the ECB only holding rates amid inflation worries. In data released yesterday, Eurozone PPI in July increased by 0.9%m/m for an 8.0%y/y print. This is higher than market expectations and adds to price pressures still present in the Eurozone.

The UK construction PMI for July fell to a fresh low of 36.7, below market expectations of 37.5 and down from last month's 38.8 reading. The contraction is the weakest since the survey began, and the embedded housing sub-index fell to 18.7. The pound remains under pressure from weak data, and with the UK earnings season gathering steam, the outlook on financials may prove to be an extra source of concern. This week's BoE meeting remains a difficult battle between inflation concerns and containing the current deterioration in growth. Nevertheless, price pressures may retain market focus - the quarterly inflation report is due on August 13. BoE expectations remain relatively stable and we stress it is volatility in ECB expectations that will be the main driver of EURGBP. Judging by Wall Street's recent performance, the UK earnings season is likely to pass without incident, and the pound's relative resilience to downside data will stay intact. We remain short EURGBP as a trade recommendation, targeting 0.7400.

The main focus in the G10 Asia session today is the RBA announcement at 0430 GMT. Our option desk is reporting that gamma is well bid ahead of the announcement. The market expects a big change in the tone of the RBA following an article last week in the Daily Telegraph. While economic data has deteriorated - notably retail sales and private sector credit last week - we think the tone of recent RBA comments coupled with data, and abstracting from recent press reports, is more consistent with a cut later in the year rather than immediately. Indeed as recently as July 28, Assistant Governor Debelle noted that there were signs of improvement in the securitised market. There has been concern over the China growth outlook, but our China economist is only forecasting a moderation in growth and policymakers there seem to be re-orientating away from combating inflation to supporting growth. We wouldn't sell AUD heading into the announcement but it is tempting to buy if there is no material change in view from the RBA. Meanwhile, in NZ RBNZ Governor Bollard reiterated this morning that he saw further scope for rate cuts. We still target AUDNZD at 1.31 over 1 month and 1.33 over 3 months.