ECB cuts rates and the euro takes some punishment
The ECB met expectations last week by cutting the eurozone interest rate to 0.75%. In addition, the deposit rate was cut to zero. This all makes the euro the second-lowest yielding currency in the market after the swiss franc, which is likely to see investors increase their use of the euro as a funding currency for carry trades into higher-yielding currencies. This should be a major factor weighing on the euro moving forward.
For many, the ECB’s rate cut did not go far enough in offering support to the eurozone’s deteriorating situation. There is a significant chance of another interest rate cut at the ECB’s next meeting in August, as there is of alternative easing measures such as another LTRO (cheap loan offering).
The post-EU Summit optimism has well and truly run its course and the market sentiment has once again turned negative. Spanish bond yields are back up at 7.0%, while global equities have tumbled for three days straight. Eurozone investor sentiment data was very poor on Monday morning and with the market already reflecting on recent weak data from the US, Japan and China, the euro has come under some pressure.
It is not all bad news for the euro, however, as we have heard today that Spain will be granted a year’s grace until 2014 to meet its deficit target of 3%. This has been insufficient to trigger any major euro bounce, which is sitting close to 3 ½ year lows against the pound and 2 year lows against the USD.
US data spooks market and risk aversion takes hold
The key monthly figure from the US labour market disappointed last Friday. It is always interesting to see how the US dollar reacts to weak domestic data and Friday’s installment proved supportive of the greenback. Dollar-friendly risk aversion was the knee jerk response, despite the fact that the downtrend in US data is likely to push the US Federal Reserve into finally pulling the trigger with regard to QE3 later this year. There is a chance that the Fed will do so on August 1st and much depends on US data in the intervening period, but we suspect Ben Bernanke & Co will choose to keep their powder dry for another month at least.
The flight to the safety of the US dollar has seen GBP/USD lose some ground in the past few sessions. The Bank of England’s decision to inject another £50B of quantitative easing into the UK’s flat lining economy was broadly priced in, though last week’s poor growth figures from the UK’s construction and services sectors in particular were not helpful for GBP. The week ahead is fairly quiet in terms of domestic data, with only manufacturing production data and trade balance data likely to receive much attention.
EUR/USD was last week’s major mover, having tumbled from above $1.26 to below $1.23 in the space of just three sessions. We have been calling for a slide down towards and below $1.20 and this latest euro sell-off has only strengthened our resolve. GBP/USD fell as well, but not by as much (it fell from $1.57 to $1.55). This cleared the way for GBP/EUR to help itself to some easy gains up above €1.26. These are clearly strong levels at which to buy the euro in the short-term, though in the longer-term we target levels even higher in the direction of €1.30.
The market will look to the meeting of EU finance ministers over the next two days for a decision to activate the buying of peripheral EU debt but as ever there remains plenty of scope for disappointment here.
End of week forecast
GBP / EUR 1.2625
GBP / USD 1.5475
EUR / USD 1.2250
GBP / AUD 1.53
Richard Driver
Analyst – Caxton FX
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