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Forex: Euro Remains Vulnerable Amid Debt Crisis, Deepening Recession

Forex: Euro Remains Vulnerable Amid Debt Crisis, Deepening Recession

2013-01-21 14:00:00
David Song, Strategist
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Talking Points

  • Euro: Monetary Policy ‘Only’ Buys More Time, EU Summit in Focus
  • British Pound: More Hawkish BoE on Tap, 4Q GDP to Contract
  • U.S. Dollar: Struggles to Hold Ground During Holiday Trade

Euro: Monetary Policy ‘Only’ Buys More Time, EU Summit in Focus

The Euro tagged an overnight high of 1.3331 amid hopes surrounding the EU Finance Minister meeting in Brussels, while the Bundesbank held an improved outlook for Europe’s largest economy and said that ‘the largely stable labor market and a better outlook for output suggest that the economic weakness won’t last all that long.’

As the EU is set to discuss the future of the European Stability Mechanism, there are reports that the group will give Portugal greater flexibility in meeting the conditions laid out by the bailout package, but the reactionary approach in addressing the debt crisis may continue to drag on the exchange rate as debt crisis continues to drag on the real economy.

Indeed, Bundesbank President Jens Weidmann warned that the growing reliance on the central bank to address the debt crisis is ‘wrong and dangerous,’ and went onto say that monetary policy can ‘only buy more time’ as the governments operating under the monetary union struggle to get their house in order. In turn, Mr. Weidmann argued that the ECB should only be focused on preserving price stability, but we may see a growing number of central bank officials show a greater willingness to ease monetary policy further as the deepening recession dampens the outlook for price growth.

As the EURUSD continues to carve a short-term top around the 1.3400 figure, we should see the bearish divergence in the relative strength index continue to take shape, and the pair may continue to threaten the upward trend carried over from the previous year as we anticipate the ECB to take additional steps in tackling the risks surrounding the region. Nevertheless, the holiday trade may keep the pair within a tight range over the next 24-hours of trading, and headlines coming out of the EU meeting may do little to prop up the single currency as European policy makers become increasingly reliant on monetary support.

British Pound: More Hawkish BoE on Tap, 4Q GDP to Contract

The British Pound regained its footing on Monday, with the GBPUSD climbing to a high of 1.5892, and the sterling may continue to retrace the sharp decline from earlier this month should the Bank of England (BoE) strike a more hawkish tone for monetary policy.

Although the U.K.’s GDP report is expected to show the growth rate contracting 0.1% in the fourth quarter, we may see the BoE Minutes talk down expectations for more quantitative easing, and the central bank may look to switch gears later this year as the Monetary Policy Committee anticipates above-target inflation over the policy horizon.

In turn, the fresh batch of central bank rhetoric may serve as a game-changer for the sterling, and we may see a sharp reversal in the pound-dollar should the central bank move away from its easing cycle. As the relative index on the GBPUSD bounces back ahead of oversold territory, the rebound from 1.5842 may gather pace in the days ahead, and we will be looking for another run at the 1.6300 figure should the MPC increase its efforts to stem the risk for inflation.

U.S. Dollar: Struggles to Hold Ground During Holiday Trade

The greenback lost ground on Monday, with the Dow Jones-FXCM U.S. Dollar Index (Ticker: USDOLLAR) slipping to a low of 10,117, but we may see the reserve currency consolidate during the North American session as U.S. traders remain offline for the holiday trade.

Nevertheless, we should see the dollar resume the advance from earlier this month as the economic docket shows a more broad-based recovery in the U.S., and the bullish sentiment surrounding the greenback may gather pace ahead of the FOMC meeting on January 30 as a growing number of Fed officials drop their dovish tone for monetary policy.

FX Upcoming

Currency

GMT

EDT

Release

Expected

Prior

EUR

18:00

13:00

ECB's Jens Weidmann Speaks on Euro Economy

--- 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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