Euro Weakness May Continue Despite Improved German Investor Sentiment, Pound Finds Support On Inflation Data

Talking Points
• Japanese Yen: Tests Support At 91.55
• Pound: Inflation Higher Than Expectations
• Euro: German Investor Confidence Rebounds
• US Dollar: Empire Manufacturing On Tap

Euro Weakness May Continue Despite Improved German Investor Sentiment, Pour Finds Support On Inflation Data

The Euro would fall to its lowest level since December 4th at 1.2603 as concerns over the impact of failing Eastern European banks added to the already pessimistic outlook for the region. A better than expected German Zew print of -5.8 following –31.0 in January lent temporary support for the single currency pushing it to as high as 1.2670 before continuing its weakness. Meanwhile, the Euro-Zone posted a sa December trade deficit of EUR 0.3 bln, up from EUR 4.0 bln the month prior. A 3.9% drop in imports lead to the deficit narrowing as consumer continue to retrench in the face of a deepening recession.

The improvement German investor sentiment couldn’t offset the negative impact of the growing banking concerns in the reguion. The troubles of the eastern European subsidiaries of Swedish and Austrian banks have lead to Moody’s warning of raring downgrades fro the western parent, which has added to the banking sector concerns. We may see continued Euro weakness as it becomes clearer that the ECB will cut rate at their March meeting and possible beyond. Central bank member Ewald Nowotny in a statement today’s said that there was room to cut rates below the current 2% but also reconfirmed that the MPC has no intention of implementing a zero interest rate policy. Now that 1.2700 has been broken 1.2500 stands as the next price level to watch.

The pound saw whipsaw price action during the overnight sessions. After falling to as low as 1.4130 sterling bulls were inspired by consumer prices printing higher than expected at 3.0% against expectation of a drop to 2.7%. Although, inflation fell to a nine month low it failed to break below the upper level of the central bank’s 1-3% target range, which helped ease deflation concerns and made a zero interest rate policy less likely. The pound would soar over 150 bps on the news to as high as 1.4310 before retracing back to 1.4240.

The lack of specific action from governments and the persistent concerns over the banking system have ushered in another bout of risk aversion, which should continue to add support for the dollar. Gold reaching a seven month high today demonstrates the flight to safety which is expected to send U.S. equity markets lower as they come back from the President’s Day holiday. The economic calendar us expected to add to the pessimistic sentiment as the Empire manufacturing reading is forecasted to have declined to –23.75 from –22.2. Meanwhile, Total Net TIC flows are forecasted to significantly increase by $20.0 billion after a $21.7 billion loss the month prior, which underlines the increased flight to safety and demand for U.S. Treasuries. However, President Barack Obam is expected to sign in the fiscal stimulus plan and GM and Chrysler are expected to complete their restructuring plans which could lead traders to turn an eye toward potential future growth.

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To discuss this report contact John Rivera Currency Analyst: jrivera@fxcm.com