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Euro Struggles Amid Growing Concerns, G7 Statement Interpreted

David Song

Talking Points

  • Euro: Exchange Rate Talks Gather Pace, ECB Retains Cautious Tone
  • British Pound: Fails to Maintain Long-Term Trend Ahead of BoE Report
  • U.S. Dollar: Larger Correction Ahead, Budget Statement on Tap

Euro: Exchange Rate Talks Gather Pace, ECB Retains Cautious Tone

The Euro pared the overnight advance to 1.3465 as a growing number of European policy makers struck a rather cautious tone for the region, and the single currency may face additional headwinds over the remainder of the week as the economic docket is expected to show a weakening outlook for Europe.

Indeed, we’re seeing a growing number of European officials comment on the Euro, with French Finance Minister Pierre Moscovici calling for a‘coordinated approach so exchange rates reflect the fundamentals of the economy in a faithful way and there are no erratic movements,’ while European Central Bank (ECB) board member Vitor Constancio argued that the exchange rate should ‘not be a target of policies’ even as the fundamental outlook for the euro-area remains tilted to the downside.

As the 4Q GDP report due out later this week is expected to show a deepening recession in the euro-area, Governing Council member Erkki Liikanenwarned that the economic downturn ‘won’t be over soon,’ and argued that government guarantees to prop up the banking sector may fuel excessing risk-taking as European policy makers take unprecedented steps to save the monetary union.

As the Long-Term Refinancing Operations repayments dampen the outlook for private sector credit, the head of the European Stability Mechanism, Klaus Regling, floated the idea of broadening the powers of the permanent bailout fund that would allow private investors to get involved in the direct recapitalization of commercial banks, but the ECB may have little choice but to carry out its easing cycle throughout 2013 as the governments operating under the single currency become increasingly reliant on monetary support.

As the economic downturn threatens price stability, there’s growing speculation that the ECB will ultimately push the benchmark interest rate to a fresh record-low over the coming months, and we may see the EURUSD threaten the bullish trend carried over from the previous year as President Mario Draghi adopts a more dovish tone for monetary policy. As the EURUSD struggles to push back above the 50.0% Fibonacci retracement from the 2009 high to the 2010 low around 1.3500, we’re still looking for a move back towards the 38.2% Fib around 1.3120, and the pair may struggle to maintain the upward trend dating back to July as the fundamental outlook for Europe turns increasingly bleak.

British Pound: Fails to Maintain Long-Term Trend Ahead of BoE Report

The British Pound failed to preserve the bullish trend from back in 2009 as the GBPUSD tumbled to a fresh monthly low of 1.5570, and the sterling may weaken further in the coming days should the Bank of England (BoE) lower its growth outlook for the U.K.

Indeed, fears of a triple dip recession has dampened the appeal of the British Pound, but the stickiness in U.K. inflation may prompt the central bank to switch gears later this year as the Monetary Policy Committee sees above-target price growth over the policy horizon.

As the GBPUSD breaks down, we may see the pair give back the rebound from June, and we would need to see a more hawkish BoE while delivering the inflation report tomorrow to see a meaningful rebound in the exchange rate.

U.S. Dollar: Larger Correction Ahead, Budget Statement on Tap

The greenback is struggling to hold its ground going into the North American trade, with the Dow Jones-FXCM U.S. Dollar Index (Ticker: USDOLLAR) giving back the overnight advance to 10,343, and the short-term pullback may turn into a larger reversal as the rally in the reserve currency remains overbought.

Nevertheless, we saw the USDJPY tumble to 93.25 and the G7 said its statement was misinterpreted and expressed concerns regarding the excessive moves in the Japanese Yen, and we may see increased market volatility ahead of the G20 meeting scheduled for later this week as global policy makers highlight greater threats surrounding the world economy.

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--- 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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