Euro Vulnerable as Weak Private Sector Lending Keeps Central Bank in Neutral

Key Overnight Developments

• Japan’s Manufacturing Sector Grew at Faster Pace in December
• Euro, British Pound Little Changed Through Asian Trading


Critical Levels



The Euro yielded another flat result in overnight trading, sinking as low as 1.4307 through the first half of the session but fully recovering to sit nearly unchanged ahead of the opening bell in Europe. The British Pound traded sideways, oscillating in a choppy 70-pip range above the US session low at 1.5868. We remain short EURUSD at 1.4881 and short GBPUSD at 1.6648.


Asia Session Highlights



Japan’s Nomura/JMMA Purchasing Manager Index rose to 53.8, showing the pace of expansion in the manufacturing sector accelerated in December from the previous month. The outcome reinforces the trends noted in industrial production figures released earlier this week that revealed overseas demand for Japanese cars was driving a rebound in output. Most significantly, the apparent recovery in manufacturing has not translated into improving labor markets. This leaves the world’s second-largest economy in a precarious position once the effects of global stimulus efforts that have driven the rebound in foreign demand begin to fade while the private sector remains moribund across much of the developed world.


Euro Session: What to Expect



The economic calendar is fairly uneventful in European trading. Switzerland’s KOF Leading Indicator is set to rise for the eighth consecutive month in December. Still, this would mark the slowest pace of improvement since the metric began first began to rebound in May. Last month, the KOF research institute that publishes the data said that “The steep climb experienced during the recent months is becoming flatter. Accordingly, the recovery of the Swiss economy may be losing momentum.” The leading indicator tracks 25 separate metrics of activity to forecast the economy’s direction over the coming six month period.

In the Euro Zone, November’s M3 Money Supply data will dissected to gauge pace of lending to the private sector. Despite record-low interest rates at 1% (and in practice much lower, hovering between 0.3% and 0.7% since June) as well as a 60 billion euro asset-buying program, lending to businesses and households has continued to contract, adding a record-low 0.5% in October. The rebound witnessed across the currency bloc over recent months may flounder if adequate credit is not available, undermining a self-sustaining recovery driven by the private sector after the effects of fiscal stimulus dissipate.

This is arguably the central question for European monetary policy at present: inflation has started to tick up as commodities (particularly oil) begin to recover but lending remains lackluster, complicating rate-setting for the ECB even as Jean-Claude Trichet and company struggle to reconcile an already fragile balance between the competing needs of relatively better-off countries like Germany and France with far more damaged economies like Spain and Greece. On balance, this means the ECB will likely be forced to remain in neutral as other central banks turn increasingly hawkish, putting the Euro at a clear disadvantage in the months ahead.

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