In the wake of the EU Summit last week, and further eurozone developments over the weekend, now is a good time to discuss how on earth the euro can be performing so strongly and how long we can expect this continue.
At present the euro is trading at a five-month high against sterling, and is continuing to hold above the key $1.40 level against the US dollar, just 1.4% from its recent high reached early last week. This strong performance has seen the single currency shake off a series of peripheral debt and bank downgrades, record-high Portuguese bond yields on the back of the country’s government collapse, and ongoing concerns over the region’s bailout fund.
Why such resilience? The key attraction to the euro is that the ECB is due to raise its base interest rate on April 7th, well ahead of a June (at the earliest) BoE rate rise and an expected 2012 Fed rate rise. In addition, the euro is continuing to benefit from solid Eastern sovereign commitment to diversify reserves via the euro. For the time being the markets appear confident that the German and French economies are strong enough to pull the eurozone through the worst-case scenarios in the periphery. Ahead of April 7th, we doubt that the single currency will come under any prolonged pressure. However, it could well prove to be a turning point.
Following the ECB rate rise, the market may refocus its attention on Portugal and the lack of progress being made towards an underlying resolution. The EU Summit was marked as a deadline for the eurozone bailout issue, but this decision has now been delayed until June. Market disappointment was actually muted to this delay but frustration could yet re-emerge. In addition, over the weekend German Chancellor Angela Merkel lost another key regional election; if this is repeated and the markets lose confidence in German political resolve to spearhead eurozone debt aid, then much of the single currency’s recent appreciation could be ceded.
We are still sterling-positive on a longer-term view, though recent UK economic data may delay improvements in the rate.
As for the US dollar, a change in rhetoric from the Fed in response to higher-than-expected fourth quarter economic growth may have improved the currency’s outlook. It was indicated that the Fed will definitely be ending QE2 in June (and perhaps earlier…), though no indications have been made as to an earlier-than-expected Fed rate rise. Unless a Fed rate rise is brought forward to this year, we do not foresee a strong dollar performance even with an increasingly positive US economic outlook.
Richard Driver
Analyst – Caxton FX
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