Caxton FX Currency Blog

Euro quickly corrects following ECB rates cut announcement

GBP – This week proved to be relatively quiet from a sterling perspective with the BoE keeping both the base rate and the asset purchase target unchanged. There was however some speculation that the BoE could raise rates sooner than expected as the manufacturing sector continued to post strong data in the form of PMI figures. The manufacturing sector currently accounts for around 11% of the UK’s total economic output and has expanded in almost every month since March 2013 and this is likely to a large contributing factor in the decision making of the monetary policy committee in the meeting later this month. Despite sterling appreciation over the past few months having made products less competitive globally and dampened the number of new export orders out of the UK, we expect output to build up some steam in Q3 especially as demand increases globally on the back of strengthening economic recovery. This week sees the release of more manufacturing data as well as employment figures out of the UK. If there continues to be signs of improvement and data exceeding the forecasted levels we could see sterling continue posting gains especially against the euro which has very little in the form of support this week.

USD – The US dollar had another steady week with both the ECB and BoE rates meetings failing to deliver anything that wasn’t already priced into the market. Data out of the US remained fairly inconsistent as the trade balance deficit widening in April as imports increased and exports fell again. It is expected that as long as the domestic expenditure areas of the economy continue to provide evidence of a Q2 rebound in growth, the Federal Reserve will stick to its programme of tapering its asset purchases. If and when this ends, we will also be able to gain a better idea of when rates could be hiked as the US economy embarks on some form of an exit strategy to prevent a knee jerk reaction to the lack of added stimulus. One positive out of US last week was the non manufacturing index which rose to a nine month high in May. The increase reflected gains in business activity, new orders and employment components showing signs that recovery in the US is gathering some pace. This week is expected to be a bit quieter with the release of PPI and retail sales data towards the back end. With inflation still remaining a threat to the US economy, the market will be keeping a close on PPI figures and we are likely to see some activity if there is a sizeable percentage change in either direction.

EUR – Data out of the eurozone at the start of the week almost guaranteed that the ECB would take action on Thursday. Inflation data out of Germany and the eurozone as a whole were down below the forecasted level with CPI data showing that the consumer price inflation increased by the smallest amount in more than four years. The ECB’s dovish tone in recent weeks has kept a lid on euro gains over the past few weeks. Following the ECB’s decision to cut the main refinancing rate by 10 basis points to 0.15% and introduce negative deposit rates we saw both the US dollar and sterling spike against the euro for a short period of time before returning to levels prior to the decision as we saw growing sentiment limit further downside pressure on the back of comments from ECB President Draghi that the euro exchange rate wasn’t a policy target and that the region’s economic recovery is a lot more important than the current levels of inflation. With signs emerging that global economic recovery is not as upbeat as originally thought there is further pressure on the eurozone to show more consistent signs of improving to prevent the euro from dropping off too much. Amid the lack of economic releases this week out of the eurozone we expect the euro to remain fairly vulnerable and we could see weakness emerge on the back of strong data from its developed economy peers.

AUD – The past month has seen a lot of changes take place in the Australia as the economy undergoes reconsolidation and borrowing costs remain at historically low levels. Despite signs of weakness emerging, the Australian dollar has remained historically high even though commodity prices have continued weakening further and the RBA decided to keep the base low at historically low levels for at least another month. Before the rates meeting, there was some mixed data out of the country with trade deficit narrowing to its smallest level in two and a half years and the house price index posting its biggest decline in over five years. Bearing this in mind it was unsurprising that the RBA left rates unchanged with uncertainty still surrounding the effect of the budgetary changes, the recent decline in investment in the mining sector which is still contributes significantly to Australian GDP growth and signs that inflation is heating up. The exchange rate has helped keep a lid on inflation and as a result the RBA have remained tight lipped on the issue but the market will be looking at consumer confidence figures and non-resource industry data even more closely before evaluating the direction of the Australian economy and the underlying strength of its currency. With some important data out of both China and Australia this week we could see some resistance broken especially if we see signs of China improving further with Chinese data currently having a more lasting impact on its neighbouring commodity linked currencies than data out of the countries themselves.

End of Week Forecast:

GBP/EUR – 1.2360

GBP/USD – 1.6820

EUR/USD – 1.3600 

GBP/AUD – 1.7970

Kamil Amin
FX Analyst
Caxton FX