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Euro Looks to ECB Take on Greece, Pound Vulnerable on Dovish BOE

Euro Looks to ECB Take on Greece, Pound Vulnerable on Dovish BOE

2010-03-04 07:23:00
Ilya Spivak, Sr. Currency Strategist
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Key Overnight Developments

• Australian Trade Deficit Narrows as Oil Leads Imports Lower
• Japan’s Capital Spending Drops Again, Threatening Recovery
• Risk Aversion Returns Amid Fears of Chinese Lending Cutoff


Critical Levels


03042010 1

The Euro and the British Pound slid 0.4 percent apiece against the US Dollar in overnight trade as Asian stocks declined, stoking safety-related demand for the greenback. We remain short EURUSD at 1.4881 and GBPUSD at 1.5765.


Asia Session Highlights

03042010 2

The US Dollar and Japanese Yen traded broadly higher on safety-related demand as stocks sold off in Asian trade, leading the MSCI Asia Pacific regional equity benchmark index down 0.6 percent after China’s Industrial Bank Co said loan growth will nearly halve this year as the government clamps down on credit on fears that the ultra-loose monetary policy encouraged amid the credit crunch will see the economy overheat if it is not reigned in, producing asset bubbles and runaway inflation.

Australia’s Trade Balance deficit narrowed to -A$1.2 billion in January – the smallest in seven months – from a revised -A$2.2 billion in the previous month as imports fell 3 percent (A$719 million), led by a 25 percent drop in overseas fuel purchases. Exports gained 1 percent (A$278 million), driven by a 7 percent jump in cross-border sales of metal ores and minerals. Japan’s Capital Spending fell 17.3 percent in the three months to December 2009, showing firms cut investments for the eleventh consecutive quarter, hinting at lingering doubt about the sustainability of the export-led recovery of recent months after the effects of global stimulus efforts are exhausted.


Euro Session: What to Expect

03042010 3

Interest rate decisions from the Bank of England and the European Central Bank headline the economic calendar. The outcome out of the UK will be at best a re-statement of the dovish posture that was on display in February’s quarterly inflation report, where the BOE said that “the pace of recovery is somewhat less strong than [previously expected, while] inflation is likely to fall back to below the target” over the medium term despite a likely uptick above 3% in the first quarter as higher oil prices and sterling depreciation feed through. As for quantitative easing (QE), central bank chief Mervyn King said that although the BOE had paused asset purchases, “it is far too soon to conclude that no more purchases will be needed.” However, last week’s disappointing fourth-quarter GDP report (which revealed a sharp 3.1% drop in private investment along with an unexpected 1.2% surge in government spending) painted a picture of an economy that is still far from self-sufficient, meaning the risks are to the downside should the BOE conclude that pausing QE was premature.

Meanwhile, the ECB announcement will likely see the market focused on central bank President Jean-Claude Trichet’s comments regarding Greece and the rest of southern Europe rather than actual monetary policy, which is almost certain to remain on hold. Indeed, looking beyond recent complications from sovereign default risk, inflation is well below the 2% target while economic recovery apparently began to falter in the fourth quarter, all of which point to an ECB that remains firmly on hold. Greek Prime Minister George Papandreou announced expanded steps to deal with his country’s gaping budget deficit yesterday; the measures entail such dramatic steps as a freeze on pensions, a cut in civil service salaries, and a broad batch of new taxes – none of which will sit well with the unions and is likely to bring continued civil unrest. Papandreou is heading to Germany and France starting Friday to seek strong endorsements for Greece’s austerity program, warning that if they don’t win enough support to calm the markets and bring down the costs of borrowing country, he will be forced to turn to the International Monetary Fund for assistance. This would be a significant slap in the face for the leadership of the European Union, whom the Greek Deputy PM Theodoros Pangalos described as being of “very poor quality” last week, illustrating that they are unable to put their own house in order without outside involvement.

Traders will be eager to hear the ECB’s perspective on the issue, particularly after Euro Zone finance minister group head and Luxembourg PM Jean-Claude Juncker told German news daily Handelsblatt that the markets could only “blackmail” the currency bloc for so long, warning that policymakers have “instruments of torture” that could be put to use if necessary. This amounts to a direct challenge to traders that have been raising bets against the Euro amid the developing sovereign debt crisis. Such an approach has famously backfired during the Asian Financial Crisis as well as when the UK was forced to drop out of the EU’s Exchange Rate Mechanism (a precursor to adopting the Euro), an episode known as the time when George Soros “broke” the Bank of England. Needless to say, the markets will be keen to test EU officials’ resolve, an outcome that is likely to see the Euro come under intense selling pressure as the situation develops.


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