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Sterling To Consolidate Further On Dovish BoE, Euro Correction On Tap

Sterling To Consolidate Further On Dovish BoE, Euro Correction On Tap

David Song, Strategist

Talking Points

  • British Pound: BoE Curbs Growth, Inflation Forecast – 1.5800 In Sight
  • Euro: Eyes 23.6% Fib For Support, IMF Strikes Cautious Tone For Italy
  • U.S. Dollar: Index Approaches December High, FOMC Minutes In Focus

British Pound: BoE Curbs Growth, Inflation Forecast – 1.5800 In Sight

The British Pound tumbled to a fresh monthly low of 1.5888 as the Bank of England kept the door open to expand monetary policy further, and the sterling may face additional headwinds over the near-term as the spillover effects from the sovereign debt crisis dampens the outlook for the region. Indeed, the BoE curbed its growth forecast and saw a risk of undershooting the 2% target on the back of subdued wage growth, but went onto say that the ‘big picture’ has not changed from February as policy makers expect to see a gradual recovery in Britain.

At the same time, the central bank warned of a disorderly outcome in the euro-area as the governments operating under the single-currency struggle to meet on common ground, and it seems as though the Monetary Policy Committee will carry its wait-and-see approach into the second-half of the year in an effort to shield the U.K. economy. Nevertheless, the BoE continued to highlight the stickiness in price growth as they see inflation staying above target through 2013, and it may become increasingly difficult for the central bank to defend its stance as underlying price pressures resurface. As the GBPUSD fails to maintain the upward trending channel from earlier this year, we expect to see a test of the 1.5800 figure for support, and the pair may trade sideways ahead of the BoE Minutes due out next week as market participants weigh the prospects for monetary policy.

Euro: Eyes 23.6% Fib For Support, IMF Strikes Cautious Tone For Italy

The Euro snapped back from an overnight low of 1.2680 amid the rebound in risk sentiment, but the single currency may face additional headwinds going into the end of the week as heightening finance costs across the region raise the risk for contagion. Indeed, the yield tied to Italy’s 10-Year debt breached 6% while the 10-year spread between Spain and German bonds widened to 500bp for the first time since November, and the ongoing turmoil in the region continues to cast a bearish outlook for the EURUSD as European policy makers struggle to restore investor confidence. In response, the International Monetary Fund argued that ‘a lot remains to be done’ in Italy as the group sees the region contracting in 2012, and the European Central Bank may come under increased pressure to expand monetary policy further as the region continues to face a risk for a prolonged recession. As we expect the ECB to carry its easing cycle into the second-half of the year, we will preserve our bearish outlook for the EURUSD, but the pair looks poised for a short-term correction as the recent decline remains oversold. As the euro-dollar comes up against the 23.6% Fibonacci retracement from the 2009 high to the 2010 low around 1.2640-50, we may see the figure provide interim support, but we will need to see the relative strength index cross back above 30 to see a meaningful rebound in the exchange rate.

U.S. Dollar: Index Approaches December High, FOMC Minutes In Focus

The greenback continued to gain ground on Wednesday, with the Dow Jones-FXCM U.S. Dollar Index (Ticker: USDOLLAR) rallying to a fresh monthly high of 10,100, but we’re seeing the reserve currency consolidate ahead of the FOMC Minutes as market participants weigh the prospects for monetary policy. As Fed officials take note of the more robust recovery paired with the stickiness in price growth, the central bank may sound more hawkish this time around, and we may see the committee continue to talk down speculation for another large-scale asset purchase program as the world’s largest economy gets on a more sustainable path. However, we may see Fed Chairman Ben Bernanke keep the door open to expand monetary policy further as the sovereign debt crisis continues to pose a threat to the global financial system, and we may see the central bank head renew expectations for additional monetary support as Mr. Bernanke continues to highlight the ongoing weakness in the private sector. In turn, a dovish statement could spark a short-term correction in the USD, and the dollar may consolidate going into the end of the week as the rally from the beginning of the month remains overbought.

--- Written by David Song, Currency Analyst

To contact David, e-mail dsong@dailyfx.com. Follow me on Twitter at @DavidJSong

To be added to David's e-mail distribution list, send an e-mail with subject line "Distribution List" to dsong@dailyfx.com.

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Fed's James Bullard Speaks on U.S. Economy

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