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Euro Optimism to Be Limited by Deepening Recession, ECB Policy

Euro Optimism to Be Limited by Deepening Recession, ECB Policy

David Song, Strategist

Talking Points

  • Euro: Cyprus to Get EUR 10-15B, Portugal Sees Deepening Recession
  • British Pound: BoE Talks Down QE- Maintains Price Stability Framework
  • U.S. Dollar: Empire Manufacturing Slows, Inflation Picks Up

Euro: Cyprus to Get EUR 10-15B, Portugal Sees Deepening Recession

The Euro climbed to 1.3105 amid reports that Cyprus will obtain a bailout package ranging from EUR 10-15B, while the European Central Bank (ECB) said commercial banks will repay another EUR 6.82B of the first Long-Term Refinancing Operations (LTRO) next week, which would raise the total contribution to EUR 235.8B.

However, as Portugal sees a deepening recession in 2013, the government now expects GDP to contract 2.3% this year versus an initial forecast for a 1.0% decline, and is looking for a one-year extension in meeting its budget target as the region struggles to return to growth.

As the governments operating under the monetary union scale back their push for austerity, the renewed risk for contagion may limit the upside for the Euro, and the single currency may continue to give back the rebound from November as we anticipate the ECB to push the benchmark interest rate to a fresh record-low later this year.

As the EURUSD remains capped by the 38.2% Fibonacci retracement from the 2009 high to the 2010 low around 1.3120, the pair may consolidate going into the following week, and we will look for a move back towards the 23.6% retracement (1.2640-50) as the fundamental outlook for the region deteriorates.

British Pound: BoE Talks Down QE- Maintains Price Stability Framework

The British Pound extended the advance from earlier this week as the Bank of England (BoE) talked down bets more quantitative easing and the sterling track higher next week should the policy statement sound more hawkish this time around.

Indeed, BoE Governor Mervyn King struck an improved outlook for the U.K. as he expects the economy to pick up in 2013, while Monetary Policy Committee member Spencer Dale argued that monetary policy must focus on price stability as the central bank sees a slow but sustainable recovery ahead. As inflation is expected to hold above the 2% target over the policy horizon, we should see the majority of the MPC retain a neutral policy stance throughout the first-half of the year, and another 6-3 split should spark a bullish reaction in the British Pound as market participants scale back bets for more quantitative easing.

As the relative strength index on the GBPUSD bounces back from oversold territory, the rebound from 1.4830 should gather pace in the days ahead, and the pair looks poised to threaten the 50.0% Fib from the 2009 low to high around 1.5260 as the BoE appears to be slowly moving away from its easing cycle.

U.S. Dollar: Empire Manufacturing Slows, Inflation Picks Up

The greenback weakened further on Friday, with the Dow Jones-FXCM U.S. Dollar Index (Ticker: USDOLLAR) slipping to a low of 10,463, but we may see the reserve currency regain its footing ahead of the FOMC interest rate decision scheduled for the following week as the central bank drops its dovish tone for monetary policy.

Although the Empire Manufacturing survey narrowed to 9.24 from 10.04 in February, the headline reading for U.S. inflation climbed an annualized 2.0% amid forecast for a 1.9% print, and heightening price pressures may push the Fed to adopt a more hawkish tone for monetary policy as the economic recovery gradually gathers pace.

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--- Written by David Song, Currency Analyst

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

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