The US dollar traded sideways against the euro on Friday but traded up to a high of 106.99 from 106.53 against the yen. Equity markets were also flat, while Treasury yields rose sharply on thin trading, with 2-year yields up by 13bp and 10-years up by 9bp. Crude futures closed down 80 cents to US$128.5/bbl but have since risen above US$130/bbl again this morning on reports that Iran nuclear talks that the US attended made little progress. Developments on Friday mostly remained focused on banking sector profitability and capitalisation of the GSEs. On the economic front, Fed's Stern (voter) said that rate cuts can't be reversed until normality returns to the financial markets, but that he was concerned about inflation risks. Our economists note that both Hoenig (who also spoke last week) and Stern still appear to see inflation as the dominant risk, in contrast to Bernanke, suggesting that material differences of opinion within the FOMC continue.

Data this week is unlikely to provide support for the dollar. Fed's Beige Book, due on Wednesday, is unlikely to show an improvement in key districts. Jobless claims on Thursday will show a likely show an uptick to 390k but is still lower than levels seen in past recessions. Other data this week includes home sales (both existing and new) on Thursday and on Friday we have durable goods and the final reading on the Uni of Michigan consumer sentiment index. We think that ongoing concern over financial market stability in the US coupled with still high oil prices should keep the dollar on the back foot for now. As such, we target EURUSD at 1.60 over 1 month. Over 3-months we look for 1.53 as we are more confident that oil's impact on headline inflation is moderating. We are short EURGBP as a trade recommendation targeting 0.74. Ahead today, there are no events scheduled in the US of note other than a continuation of the earnings season.

Bank of England deputy governor Sir John Gieve noted on Friday that a recession in the UK cannot be ruled out and inflation would likely stay well above 4% for much of the rest of the year. Despite the obvious price pressures the MPC's emphasis remains with downside growth risks. Nevertheless, expectations of further easing may be overdone, as Gieve acknowledged that the monetary accommodation achieved through 3 rate cuts since Q4 2007 has been offset by ongoing problems in credit markets. Given recent events, such stress is likely to continue and the BoE would not find any compelling argument for a cut if the benefits are ambiguous at best. In other data, net public debt rose to GBP9.2 bn, above expectations of GBP 7.4bn. In addition, annualised M4 money supply hit 11.5%, well above expectations of 9.7%. Despite Gieve's comments, we believe market pricing of GB-negative events is complete, and further deterioration in Eurozone data will put pressure on stretched long EURGBP positions. We are short the cross as a trade recommendation and target a return to 0.74.

ECB President Trichet surprisingly chose to focus on downside risks in comments published on Friday. He warned that a significant market correction remains likely and the ECB is not pre-committing to anything. However, the ECB's base case for growth is still a trough in Q2 and Q3 and further increases in oil and commodity prices are a concern. On Thursday newswires reported that the EU parliament has drafted a call for the ECB's inflation objective to be shifted upward from the "close to, but below 2% requirement". Any such change would require a change of the Maastricht criteria and is unlikely to happen anytime soon. Current talk signals politician's unease with rising interest rates. On Wednesday Eurozone HICP inflation was confirmed at 4.0%. Core inflation (ex food, tobacco and energy) came in at 1.8% from 1.7% in May. The pick up in headline HICP (0.4% m/m, prior 0.6%m/m) was again driven by food and energy prices. Looking ahead, we expect inflation to pick up to 4.3% in August, which is one of the reasons behind our call that the ECB will likely raise policy rates in September by 25 bp to 4.5%. We are now short EURGBP as a trade recommendation on expectations for a less hawkish ECB and further deterioration in European growth figures. Sterling may also benefit from a rebound in risk appetite as fears over the financial sector ease.

SNB Vice Chairman Phillip Hildebrand warned in comments published on Friday that it would be 'naive' to call the end of the credit crisis, as it had now entered a second phase in which the real effects of economic weakness is hitting financial markets. He said monetary policy is especially in an uncomfortable situation and warned that commodities and food price developments could endanger price stability. His comments were not specifically targeted at monetary policy in Switzerland, but his concern over inflationary pressures are in contrast to SNB's Jordan remarks earlier this month, where he stated that current SNB monetary policy is appropriate to achieve price stability in accordance with the bank's targets. The CHF has fallen from recent highs as risk sentiment improves but the lack of consolidation in risk appetite should remain supportive for the franc. We continue to see a hike in Q3 by the SNB, which should support the CHF further out. We recommend to sell rallies in USDCHF and EURCHF.

The week in Australasia includes Australian CPI for Q2 on Wednesday and an RBNZ meeting on Thursday. While we expect the RBNZ to keep rates on hold on Thursday, we do eventually see them cutting rates in September. Australian terms of trade for Q2 were released on Friday and were better than expected. Export prices for Q2 surged by 13.5% q/q, exceeding expectations of 10% q/q, while import prices rose by 1.4% q/q, less than market expectations of 1.7% q/q. The rise in export prices reflects a surge in coal prices (up 54%), metals (27%), and petroleum related products (18%). Australian terms of trade are 25% above their 5-year average, which fully justifies the AUD REER being 11% above its five-year average. On that basis, AUD can remain relatively supported while commodity prices continue to hold up. We continue to target AUDUSD at 0.97 over 1 month and 0.93 over 3 months.

BoJ minutes from the June meeting showed greater vigilance by BoJ members over rising inflation but members agreed that downside risks to growth remain high. The majority view is that although inflation expectations in Japan warrant close monitory, the likelihood of second-round effects remain low. In comments on Friday, BoJ Shirakawa said that the BoJ is now putting equal emphasis on upside and downside risks, marginally shifting to a more hawkish view in noting that stable inflation expectations are important for the world's central banks. He said Japan's economy is now more resilient to external shocks than before, but we believe the BoJ will continue to focus on downside risks as the global economy continues to correct. We target USDJPY at 105 as risk appetite remains unstable. Japan is closed for a public holiday today.