Euro Rally at Risk as ECB Mulls Negative Interest Rate Policy

Talking Points

• Euro: 4Q GDP Disappoints- ECB Report Warns of Lower Growth, Inflation

• British Pound: Extends Losses Ahead of Retail Sales, RSI Approaching Oversold

• U.S. Dollar: Continuing Claims Lowest Since 2008, Fed’s Bullard on Tap

Euro: 4Q GDP Disappoints- ECB Report Warns of Lower Growth, Inflation

The EURUSD tumbled to a fresh weekly low of 1.3314 as economic activity in the euro-area contracted 0.6% during the fourth quarter - marking the biggest decline since 2009 - and the deepening recession should produce further headwinds for the single currency as it raises the European Central Bank’s (ECB) scope to lower the benchmark interest rate further.

At the same time, the monthly report by the ECB showed the growth outlook was trimmed to reflect zero growth for 2013, while inflation is expected to hold below the 2% target over the next two-years as the debt crisis continues to drag on the real economy. In response, the European Commission announced that ‘a member state may be given a longer time to correct its excessive deficit if a worsening economic situation prevents it from reaching the agreed objective,’ and we may see the governments operating under the single currency continue to call upon the ECB as they become increasingly reliant on monetary support.

As the fundamental outlook for the euro-area turns increasingly bleak, ECB Vice President Vitor Constancio said adopting a negative interest rate policy remains ‘a possibility,’ and warned that the banking sector remains fragile amid negative growth rates in private sector credit. As the Governing Council adopts a more dovish tone for monetary policy and turns its attention to the deepening recession, we should see the central bank continue to embark on its easing cycle, and President Mario Draghi may show a greater willingness to push the benchmark interest rate to a fresh record-low in an effort to encourage a sustainable recovery.

As the EURUSD manages to hold above the 50-Day SMA (1.3272), we may see the pair preserve the ascending channel dating back to July, but we may the euro-dollar threaten the bullish trend as we’re looking for a move back towards the 38.2% Fibonacci retracement from the 2009 high to the 2010 low around 1.3120.

British Pound: Extends Losses Ahead of Retail Sales, RSI Approaching Oversold

The British Pound extended the decline from earlier this week, with the GBPUSD slipping to an overnight low of 1.5491, and the sterling may continue to give back the rebound from June as market participants increase bets of seeing the Bank of England (BOE) expand its asset purchase program beyond the GBP 375B target.

Nevertheless, a report by the Council of Mortgage Lenders showed repossessions in the U.K. slipped to 33.9K during the previous year to mark the lowest print in over five years, and we may see economic activity pick up over the coming months as the central bank maintains a highly accommodative policy stance to encourage a stronger recovery.

As the Funding for Lending Scheme continues to work its way through the real economy, we may see the BoE stick to the sidelines throughout 2013, and we may see the sterling regain its footing over the remainder of the week as the economic docket is expected to show a rebound in retail spending.

Although the GBPUSD has failed to maintain the upward trend dating back to 2009, we’re seeing the relative strength index come up against oversold territory, and we may see a more meaning rebound in the exchange should the sales report highlight an improved outlook for the U.K.

U.S. Dollar: Continuing Claims Lowest Since 2008, Fed’s Bullard on Tap

The greenback bounced back on Thursday, with the Dow Jones-FXCM U.S. Dollar Index (Ticker: USDOLLAR) climbing to a high of 10,324, and the reserve currency may continue to gain ground over the remainder of the week as the fundamental outlook for the world’s largest economy improves.

Indeed, continuing jobless claims slipped to 3114K during the week ending February 2 to mark the lowest reading since July 2008, and the ongoing improvement in the real economy should continue to prop up the USD as it limits the Fed’s scope to expand the balance sheet further. As St. Louis Fed President James Bullard, who serves on the FOMC this year, is scheduled to speak later today, we should see the central bank hawk talk down bets for more quantitative easing, and the dollar may trade higher going into the G20 meeting on tap for the end of the week as central bank shows a greater willingness to conclude its easing cycle this year.

FX Upcoming

Currency	GMT	EDT	Release	Expected	Prior
USD	15:30	10:30	US Senate Banking Committee Hearing on Dodd-Frank Act
USD	15:30	10:30	Fed's Tarullo Testifies Before Senate on Regulation
USD	17:50	12:50	Fed's Bullard to Speak on Economy in Mississippi
NZD	21:45	16:45	Retail Sales Ex Inflation(QoQ) (4Q)	1.4%	-0.4%

--- 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.

Will the EUR/USD Resume the Downward Trend From 2011? Join us in the Forum

Related Articles: Weekly Currency Trading Forecast

DailyFX provides forex news and technical analysis on the trends that influence the global currency markets.
Learn forex trading with a free practice account and trading charts from FXCM.