U.S. Markets closed

Potential Rally Fuel for 2 European Currencies

Kathy Lien

Talking Points:

  • Eurozone PMI Data Due Thursday
  • Controversial Comments from ECB President Draghi
  • BoE Reaffirms Its Optimism

The euro (EUR) ended Wednesday unchanged against the US dollar (USD), which was noteworthy considering the steep slide in other major currencies. The resilience was driven by hopes that Eurozone data starting with Thursday’s Eurozone PMI numbers will continue to surprise to the upside.

With the major US dollar risks—the debt-ceiling debate and Fed tapering—behind us for the time being, relative growth has taken on increased importance for the EURUSD. If Eurozone data does surprise to the upside, investors may begin to price in a more neutral and less-dovish stance on the part of the European Central Bank (ECB).

Given the sharp rise in the expectations component of the ZEW survey, we would not be surprised if the Eurozone recovery gained momentum, although the central bank's caution should not be taken lightly, either, as there is vulnerability in the Eurozone economy.

The big story for EURUSD on Wednesday was ECB President Mario Draghi's comment that the ECB won't hesitate to fail banks in next year's stress tests. The central bank released its methodology for reviewing asset quality, and as expected, the capital requirement for banks will be 8%, a level which most banks currently exceed. Draghi said quite simply that if any banks fail to meet the requirements, "they have to fail, there's no question about that."

BoE Optimism Likely to Prop up the Pound

The latest Bank of England (BoE) meeting minutes provided no support to the British pound (GBP), which traded lower against the dollar and euro on Wednesday. The decision to leave interest rates and quantitative easing unchanged this month was unanimous, but the minutes were slightly more optimistic.

The monetary policy committee has grown more positive about the sustainability of the UK economic recovery and indicated that the unemployment rate could fall faster than anticipated, boosting speculation that the first rate hike will occur in 2015 instead of 2016, as initially signaled.

The central bank also raised its growth forecast to "around 0.7% a quarter or a little higher," which is "stronger than expected at the time of the August inflation report." This suggests that the BoE will also boost its GDP forecasts when the November inflation report is released.

So while all members of the central bank felt that monetary policy should remain unchanged, on balance, policymakers grew less dovish, which is a notable feat considering that the US fiscal crisis at the beginning of the month posed serious risk to the global economy.

Given the central bank's more optimistic outlook, we continue to believe that GBPUSD is poised for a recovery and a stronger move higher.

See also: A GBP/CAD Set-up All Traders Can Agree on

By Kathy Lien of BK Asset Management

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.