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Euro Carving Top, Relief Rally To Falter As ECB Leans Toward ZIRP

Euro Carving Top, Relief Rally To Falter As ECB Leans Toward ZIRP

2012-06-14 14:10:00
David Song, Strategist

Talking Points

  • Euro: Spanish Yield Approaches 7%, ECB Leading Towards ZIRP
  • British Pound: Maintains Range, U.K. To Announce Credit-Easing Measures
  • U.S. Dollar: Carving Short-Term Base, Underlying Inflation Remains Sticky

Euro: Spanish Yield Approaches 7%, ECB Leading Towards ZIRP

The Euro climbed to an overnight high of 1.2588 as German Chancellor Angela Merkel told parliament that addressing the debt crisis will be the ‘central topic’ at the G20 Summit next week, and the EU may continue to look towards the international community for further assistance as they struggle to stem the heightening risk for contagion. Indeed, Spain’s 10-Year yield continued to approach the 7% mark as Moody’s cut the region’s credit rating to Baa3 from A3, while Italy sold EUR 3.0B in three-year notes yielding 5.30%, which compares to the 3.91% offered in May.

At the same time, a report by the Bank of Spain showed commercial banks borrowed a record EUR 287.8B from the European Central Bank in May, and there’s increased speculation that the Governing Council will act in July as the fundamental outlook for the region turns increasingly bleak. It seems as though a growing number of central bank officials are showing their support for a zero-interest rate policy (ZIRP) amid the risk for a prolonged recession, but we may see the ECB implement a range of tools to shore up the ailing economy as European policy makers struggle to restore investor confidence. As the EURUSD maintains the range-bound price action carried over from the previous week, we should see the 23.6% Fibonacci retracement from the 2009 high to the 2010 low around 1.2640-50 continue to provide resistance, and the pair may continue to track sideways ahead of the Greek elections amid the risk of a euro-area breakup.

British Pound: Maintains Range, U.K. To Announce Credit-Easing Measures

The British Pound pared the decline from the previous day to maintain the range carried over from the previous week, but the GBPUSD may struggle to make another run at the 1.5600 figure amid speculation for additional monetary support. According to a report by the Financial Times, the Bank of England and the HM Treasury will announce a credit-easing initiative to shore up the ailing economy, while there’s growing speculation the Monetary Policy Committee will continue to carry out its easing cycle in June in order to further shield the U.K. from the debt crisis. However, as BoE officials anticipate to see a more robust recovery later this year, the stickiness in underlying inflation may keep the central bank on the sidelines, and we may see the GBPUSD track sideways ahead of the meeting minutes as investors weigh the outlook for monetary policy. A 7-2 split in the MPC is likely to foster a bearish outlook for the sterling, and we may see the GBPUSD threaten soft support around the 50.0% Fib from the 2009 low to high around 1.5270 as the central bank keeps the door open to expand monetary policy further.

U.S. Dollar: Carving Short-Term Base, Underlying Inflation Remains Sticky

The greenback struggled to hold its ground on Thursday, with the Dow Jones-FXCM U.S. Dollar Index (Ticker: USDOLLAR) falling back to a low of 10,146, and market participants may continue to move away from the reserve currency as they increase their appetite for risk. Nevertheless, we remain bullish against the greenback as the stickiness in underlying inflation limits the Fed’s scope to implement another round of quantitative easing, and the USDOLLAR appears to be carving out a short-term base ahead of the FOMC interest rate decision as the central bank continues to soften its dovish tone for monetary policy.

--- Written by David Song, Currency Analyst

To contact David, e-mail Follow me on Twitter at @DavidJSong

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