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Japanese government bonds staged their biggest one-day advance in five months

but failed to lift European bonds. Those issues have trended lower, taking their cues from the U.S. Treasury's performance before the weekend.

Despite continued weak economic data, European bond yields are near their highest levels of the year. The recent inverse relationship between European bonds and stocks has broken down, as most European equity markets are also weaker. The dollar is continuing to rise against both the yen and euro.

The yield on the benchmark JGB dropped 20 basis amid signs that the

Bank of Japan

is being pressured to stabilize bond yields. The yield now stands near 2.16%, down from the 2.44% seen in the middle of last week. There is also increased speculation that the BOJ could cut rates at this Friday's board meeting.

Unlike most countries, Japan has taken the extraordinary step of pushing overnight rates below the discount rate. This means that an official discount rate cut is less significant because it is not the floor for interest rates, as is normally the case. The overnight rate trades at just below 0.25%. A cut in this rate may produce a sharp spike in bond prices, but it might not be sustained as the cut would most assuredly be the last.

The dollar is testing the 114 area against the yen.

While there is scope toward 114.50 to 114.70 yen, many participants will be reluctant to aggressively buy dollars against the yen ahead of the end of the fiscal year on March 31.

Europe continues to report soft economic data, which offer a stark contrast with strength of the U.S. economy. Germany reported that industrial production was unchanged in December for a 0.3% year-over-year decline. On a two-month view, which is used to smooth out the volatility of the series, industrial output fell 1.5% compared to the September-October period. Germany is expected to report its January employment statistics tomorrow.

The unemployed queue is expected to have grown for the third consecutive month. Industrial output fell in the U.K. for the fifth consecutive month in January, dropping 0.8%. The narrower but more telling measure, manufacturing output, fell 0.6% in January for a 1% year-over-year decline. The market consensus had expected only a 0.2% decline. Meanwhile, the preliminary signs of increased price pressures may be surfacing. Producer output prices rose for the second time in as many months. They increased 0.1% in January and are unchanged from a year ago. Input prices rose 0.4% and are down almost 7% from last January.

Voters in the German state of Hesse dealt the ruling SPD-Green coalition a stunning defeat over the weekend.

This center-left coalition has been running the state for the past eight years, but it was toppled chiefly because of the failure of the Greens to maintain their support.

For its part, the SPD garnered more votes than it did in the last election in 1995. The center-right's campaign was run against the federal government's efforts to extend German citizenship. The electoral results will have far-reaching implications. With the loss of Hesse, the SPD has lost its majority in the


, the upper chamber of the national parliament. The CDU can now obstruct the SPD-Green coalition's legislative agenda. Perhaps the electoral setback will encourage SPD-Green officials to close ranks after several spats since the coalition was swept to power last fall.

New Zealand announced a change in the way it conducts monetary policy, and this set the New Zealand dollar to its best levels in nine months against the U.S. dollar.

In recent days, the New Zealand dollar, or the kiwi as it is nicknamed, has lagged behind the smart advance of the other currencies in the dollar bloc -- namely the Australian and Canadian dollars. New Zealand indicated that it would scrap its monetary index, a combination of short-term interest rates and a trade-weighted currency index, that it had used to guide monetary policy.

Instead the

Reserve Bank of New Zealand

will set an official interest rate, which many expect will be above where the 90-day T-bill was trading before the weekend (4.07%) given the underlying strength of the New Zealand economy. The yield on the 90-day bill rose 31 basis points earlier today before settling back to post a gain of 17 basis points. In addition, going forward, the RBNZ will outline its policy in quarterly statements instead of its current practice of giving weekly guidance. The Canadian and Australian dollars are also extending their recent gains.

Marc Chandler is an independent currency strategist whose column appears weekdays on