The dollar failed to sustain a move above 107.5 against the yen and weakened to...

... lows
of 106.75 before rebounding to 107.0. The yen will gain some support from lower oil
prices and a rally in the Nikkei index. Investment flows will, however, remain
negative for the yen with latest figures recording outflows of US$12.1bn into
overseas bonds in the latest week. The underlying Japanese balance of payments
position will remain strong which will lessen the risk of sharp yen losses.

The US authorities have continued to exert strong pressure on the Chinese
authorities to let the yuan strengthen with Treasury Secretary Snow calling for a
move to let the yuan appreciate now. The underlying pressures will continue,
although there is still the risk that US political pressure will reinforce Chinese
resistance.

Regional exchange rate policies will remain a very important focus with the Hong
Kong Monetary Authority (HKMA) widening the dollar's trading band. The currency will
be allowed to trade in a 7.75-7.85 range against the dollar to help deter
speculative inflows and ease downward pressure on interest rates. The Hong Kong move
will maintain speculation that the Chinese authorities will also make a move to
offer greater yuan flexibility. In this context, the Hong Kong move could be seen as
indicating that they are expecting a Chinese move in the near term.

The dollar was unsettled slightly by reports that Kore would not look to increase
reserves further. These comments will maintain speculation over wider reserve
diversification. The developments over the past two weeks continue to suggest that
there will be Asian moves to allow stronger currencies in the medium term and this
will tend to weaken the dollar in Asia even if there is near-term resistance to a
Chinese move.

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