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Euro Hit by Contagion Threats- Pound to Rally on BoE Minutes

Euro Hit by Contagion Threats- Pound to Rally on BoE Minutes

David Song, Strategist

Talking Points

  • Euro: Cyprus Poses ‘Psychological Contagion,’ Bank Deposit Levy ‘Catastrophic’
  • British Pound: Core U.K. Inflation Tops Forecast- BoE Minutes on Tap
  • U.S. Dollar: FOMC Takes Center Stage- Updated Forecasts in Focus

Euro: Cyprus Poses ‘Psychological Contagion, Bank Deposit Levy ‘Catastrophic’

The Euro weakened to 1.2914 as the EU pushed Cyprus to draw up EUR 5.8B from levying commercial bank deposits, but we may see the periphery country struggle to secure the EUR 10B bailout as President Nicos Anastasiades lacks enough support to gain government approval.

As the Cypriot parliament continues to postpone their vote on the unprecedented measure, former Cyprus central bank governor Athanasios Orphanides warned that the bank deposit levy ‘only makes the economic climate worse,’ and argued that the EU should consider alternative measures as the tax on savings would have ‘catastrophic’ consequences for the euro-area.

At the same time, former European Central Bank (ECB) member Lorenzo Bini Smaghi said that the turmoil in Cyprus may have a ‘psychological contagion’ effect as its citizen’s line up to raid their savings, and the Euro may face additional headwinds over the near-term as the debt crisis continues to dampen the fundamental outlook for the region.

As Europe struggles to emerge from the recession, we should see the ECB maintain an accommodative policy stance throughout 2013, but we may see a growing number of central bank officials show a greater willingness to push the benchmark interest rate to a fresh record-low as the debt crisis raises the risk for a prolonged recession.

Despite the negative headlines surrounding the euro-area, we’re seeing the EURUSD hold above the 200-Day SMA (1.2863), and the pair may test the range-bound price action seen during the previous week as it has yet completely fill-in the gap from the Sunday open.

British Pound: Core U.K. Inflation Tops Forecast- BoE Minutes on Tap

The British Pound advanced to a high of 1.5143 amid heightening price pressures in the U.K., and the sterling may continue to retrace the sharp decline from the previous month should the Bank of England (BoE) Minutes sap bets for more quantitative easing.

Although the headline reading for U.K. inflation increased an annualized 2.8%, the core rate climbed 2.3% amid forecasts for a 2.2% print, and we may see a growing number of BoE officials adopt a more hawkish tone for monetary policy as price growth is expected to hold above the 2% target over the policy horizon.

Indeed, the policy statement may show the majority of the Monetary Policy Committee favor a neutral policy as the central bank anticipates a slow but sustainable recovery in the U.K., but we may see BoE conclude its easing cycle later this year as the Funding for Lending Scheme continues to work its way through the real economy.

In turn, a more hawkish tone from the BoE may trigger a move back towards the 50.0% Fibonacci retracement from the 2009 low to high around 1.5260, but we may see a more meaningful rebound in the exchange rate should the central bank no longer see scope to expand the balance sheet further.

U.S. Dollar: FOMC Takes Center Stage- Updated Forecasts in Focus

The greenback pushed higher on Tuesday, with the Dow Jones-FXCM U.S. Dollar Index (Ticker: USDOLLAR) climbing to a high of 10,504, but we may see the reserve currency consolidate over the next 24-hours of trading as the FOMC interest rate decision takes center stage.

Indeed, we’re seeing a fairly muted reaction to U.S. housing starts (0.8%) and building permits (4.6%) as market participants turn their attention to the Fed’s two-day meeting, and the fresh batch of central bank rhetoric along with the updated forecasts may heighten the bullish sentiment surrounding the reserve currency as the FOMC takes note of the more broad-based recovery in the world’s largest economy. In turn, we may see a growing number of Fed officials adopt a more neutral to hawkish tone for monetary policy, and the central bank may start to discuss a tentative exit strategy as the outlook for growth and inflation improves.

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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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