ECB President Draghi calms market fears by pledging the ECB will do “whatever it takes”

The president of the European Central Bank, Mario Draghi, has asserted this morning that, within its mandate, “the ECB is ready to do whatever it takes to preserve the euro, and believe me, it will be enough.” He added that the solution was “more Europe,” which again was music to the market's ears. Unsurprisingly, the euro has rallied on Draghi’s positive comments; EUR/USD has bounced by almost two cents.

These comments build on the relief story that was delivered yesterday by ECB policymaker Nowotny. Nowotny indicated that the European Stability Mechanism could be granted a banking license, which would in turn increase its lending capacity. The eurozone’s inadequate ‘firewall’ has long been a major gripe of investors and the fact that there are members within the ECB looking to address this was greeted with open arms. It goes without saying that Nowotny’s comments are a long, long way from becoming policy and he will certainly meet some stiff opposition within the central bank.

This week’s jawboning really ramps up the pressure on the ECB to deliver some emergency policy response of note at its monthly meeting next Thursday. If it fails to deliver a convincing plan on how to bring down Spanish and Italian bond yields which are threatening to force both countries into bailout territory, the euro is likely to come under some fresh and considerable selling pressure. Restarting the ECB’s bond-buying programme, which has been on hold for several months, would be welcomed enthusiastically, as would quantitative easing. Some action will surely come next week, as the ECB is forced to fill the policy vacuum left by the EU’s dithering politicians.

Richard Driver
Analyst – Caxton FX
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Market fears reach new heights as Spain edges closer to a sovereign bailout

The bad news for the euro just keeps on flowing. Spanish 10-year bond yields have now risen to a fresh euro-era high above 7.60%, which is a fairly accurate bellwether of market tensions that have built towards Spain and the debt crisis as a whole in recent sessions. Sustained yields above 7.0% pushed Greece, Portugal and Ireland into requesting a bailout and the chances of Spain following suit are rising all the time – another few weeks at current levels and Spain may have no choice but to ask for help.

Meanwhile, German 10-year bonds have recently fallen as low as 1.14%, and 6-month bond yields have even dipped in to negative territory; such is the appetite for safe havens, investors are actually willing to accept losses just to park their funds in the safety of German short-term debt.

The Spanish regional govenrment of Valencia has asked the central government for financial aid, and six other regions including Catalonia and Murcia are expected to do the same. Considering a €100bn bailout was only signed off for Spain’s crumbling bank sector on Friday, these signs of panic from Spain’s regions are the last thing Spanish PM Rajoy needs, particularly as he is trying to quell market fears by insisting that Spain will not require a full-blown sovereign bailout. Spain’s economy minister De Guindos is meeting his German counterpart Schaeuble today and there will be suspicions that a full sovereign bailout will be considered.

The IMF may well be hardening its stance on granting aid to failing eurozone economies, if the rumours of a possible withheld contribution towards Greece’s next aid tranche. So again, these Spanish headlines have come at unfortunate moment.

Spain is continuing to call for intervention from the ECB, De Guindos said on Saturday that "somebody has to bet on the euro and now, given the architecture of Europe isn't changed - who can make this bet but the ECB." If the ECB restarts its programme of buying up distress debt, then Spain can stop paying such high borrowing costs. The ECB has stood firm on this issue for nineteen straight weeks, claiming that the lead on solving the debt crisis should be taken by EU politicians. Stodgy progress in this regard is likely to force the ECB’s hand in the end, particularly as Italy edges closer to disaster.

Spain has major repayments to be made by October, so a full-scale Spanish bailout could well come before then. Amid all these concerns around Spain, Greece is heading towards the exit door, so it should to come as a surprise when we reiterate our bearish view of the euro.

Adam Highfield
Analyst – Caxton FX
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Caxton FX Weekly Outlook: further pain in store for euro

Spanish debt concerns drive GBP/EUR even higher

Spanish 10-year bond yields are up at 7.50% today, which represents yet another fresh euro-era high. One of Spain’s largest regional governments, Valencia, has requested financial help from the central government, and there are plenty of indications that more regions will follow suit. This has triggered widespread fears that the Spanish sovereign itself will need a formal bailout, in addition to the bailout that was signed off for the country’s banks on Friday. In addition, the Bank of Spain has said today that the country’s economy shrunk by 0.4% in Q2, in addition to its 0.3% contraction in Q1.

Greece is also back in the headlines this week; reports have emerged that the IMF may not contribute to the next aid tranche that the country needs by September to avoid insolvency. The IMF, along with the rest of the Troika, will be in Greece this week assessing the country’s spending cuts and reforms. The Troika seems highly likely to give a negative assessment of Greek progress.

On top of these debt–related issues, the week ahead presents plenty of risks for the euro in terms of economic data. Tomorrow’s set of eurozone, German and French PMI growth figures are expected to remain at very weak levels, in fact almost entirely in contraction territory. Wednesday brings a key German business climate survey, which is expected to hit a fresh-two year low. All of this negative eurozone data is likely to increase speculation as to another interest rate cut from the ECB early next month.

MPC minutes do little to hurt the pound

The MPC’s meeting minutes revealed a 7-2 vote in favour of the July quantitative easing decision, which is no great surprise in light of poor UK growth data, weak domestic inflation and rising risks from the eurozone. Sterling has actually weathered the recent domestic quantitative easing storm very well and we are not expecting another dose of QE in the next few months, if at all (provided a rapid deterioration in eurozone conditions can be avoided). An interest rate cut was discussed at the MPC’s last meeting, but we expect this will be the committees’ last resort and we are not expecting this will be utilized this year.

The week ahead brings the preliminary UK GDP figure for the second quarter of the year. Consensus expectations are of a 0.2% contraction and whilst an undershoot of this estimate would likely apply some short-term pressure on sterling, we still take a positive view of sterling moving forward, as we do of all safer-currencies.

The week ahead also brings the advance US GDP figure for the second quarter. A further slowdown is expected, though until the Fed makes some clear signals as to QE3, the dollar should remain on the offensive.

End of week forecast

GBP/EUR posted fresh 3 ½ year highs up towards €1.29 over the weekend and while the pair is trading only marginally above the €1.28 level at present, we expect new highs to be reached soon. €1.30 has come into view quicker than we expected and is now a realistic target in the coming fortnight. Heavy losses in the EUR/USD, which itself it trading at more than a two-year low below $1.21, have taken their toll on GBP/USD. Sterling has given back two cents to the dollar since last Friday, and is currently trading at $1.55. We expect this pair to revisit the $1.54 level in the coming sessions. Soaring peripheral bond yields should ensure global stocks remain under pressure, which is likely to pave the way for further dollar gains.

GBP / EUR 1.2925
GBP / USD 1.54
EUR / USD 1.1920
GBP / AUD 1.5200

Richard Driver
Analyst – Caxton FX
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The aussie dollar is flying high but where does it go from here?

Australian dollar has gained by over 6.5% over the pound in the past two months, strengthened by nearly 7.5% against the USD in the past six weeks, and hit fresh record highs against the euro only this afternoon. The Reserve Bank of Australia cut its interest rate to 3.50% in early June and its key trading partner China continues to slowdown, so what is driving this latest rally in the aussie dollar?

One major factor fuelling the current positivity towards the AUD is the development that the German central bank, the Bundesbank, is set expand its portfolio of Australian assets. The eurozone crisis has caused central banks all over the world to review their reserve allocations and among others who are set to invest in Australian assets is the Czech central bank. This factor has completely overshadowed any dampening effects you might have expected as a result of the collapse of risk appetite that saw many higher-yielding currencies and equities decline since early May.

In addition, Australian economic data has in general held up remarkably well given the decline being seen in the Chinese economy (Chinese GDP has slowed down from a pace of 9.5% to 7.6% in the past year). Recent data revealed that Australian GDP expanded by an impressive 1.3% in Q1 of this year, well up from Q4 2011’s figure of 0.6%. This domestic economic strength gave the Reserve Bank of Australia the confidence not to cut its interest rate again in July.

However, we are seeing considerable risks of a rate cut in August as this domestic performance looks unlikely to persist. Recent Australian data has taken a downturn, particularly in terms of the domestic labour market. As well as July’s weak labour numbers, forward-looking indicators point to further softness.

Importantly, data revealed a sharp drop in Chinese imports from Australia in June and weekly New South Wales coal shipments have also fallen off this month. Equally, Chinese steel production has declined and its iron ore inventories have climbed, suggesting waning demand for aussie exports in the months ahead. As well as further deterioration in Chinese growth, we take a gloomy view as to the outlook for global growth and financial conditions, driven not least by eurozone risks. If a rate cut doesn’t come in August, we would be very surprised if it didn’t come in September.

For these domestic and international reasons, we see the AUD rally halting soon. AUD/USD should fail to sustain any breach of 1.05 and we should see this rate head back down toward and below parity in the coming months. In terms of GBP/AUD, downside scope is looking increasingly limited. The aussie is deep in overbought territory and we expect 1.55 will be seen once again before long. In addition, when the aussie dollar does endure its downward correction, it could well be quite a brutal move.

Richard Driver
Analyst – Caxton FX
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MPC minutes reveal a 7-2 vote to in favour of QE, where does the BoE go from here?

Yesterday’s release of the Bank of England MPC meeting minutes revealed a 7-2 vote to increase add £50bn of quantitative easing to the UK economy, taking the total of the BoE’s asset-purchase facility to £375bn. With the UK having entered a double-dip recession and showing few signs of a return to growth in the near future, the MPC understandably felt the time was right to give the UK economy another helping hand, particularly with external threats from a eurozone downturn increasing almost perpetually.

Expectations were pretty high for a unanimous vote in favour of the MPC’s July QE decision. However, for the first time since 2009, there was dissent when the majority voted in favour of QE. Dale and Broadbent both voted against the proposal on the grounds that there was sufficient stimulus in place. However, this less dovish aspect can be seen to be balanced by the additional discussion of the larger £75bn QE option, as well as a potential interest rate cut.

The decision was based on a fairly grim near-term growth outlook. The UK economy is struggling to emerge from its second recession in four years, and updated growth forecasts released by the International Monetary Fund earlier this week indicated that growth may be as low as 0.2% over 2012. This morning’s UK retail sales growth data for June came in well below expectations at 0.1%, while the PMI surveys from the UK’s manufacturing, services and construction sectors painted an overall very negative picture.

UK price pressures have also eased to a greater extent than expected over the past few months particularly; inflation is now at 31-month low of 2.4%. The minutes revealed that there was the consensus that more QE is necessary in order for the BoE’s inflation target to be met in the medium term.

The increased discussion and possibility of a cut to what is already a record-low interest rate of 0.50%, certainly did not go unnoticed. The minutes revealed that the MPC could review a possible interest rate change once the effects of its Funding for Lending Scheme (FLS) have been assessed. However, the effects of the FLS will not be ascertained for several months, so we can be confident that a BoE rate cut is not imminent.

So what about the MPC’s August meeting? It looks likely to be a classic wait-and-see meeting; waiting for the effects of the FLS and QE decisions to surface. In fact the MPC could remain on the sidelines until November, when the current round of QE has run its course. As ever, this comes with the caveat that negative eurozone developments are more than capable of accelerating the need for additional monetary stimulus.

Richard Driver
Analyst – Caxton FX
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BoE announces its Funding for Lending scheme, but how much impact will it have?

The Bank of England announced last Friday that it will start its funding for lending scheme in August, with £80bn being offered to banks at very little cost. The goal of the initiative is to stimulate economic growth through increased bank lending, which has remained constricted for several recession-hit years.

The Funding for Lending scheme follows a previous plan with similar aims called Project Merlin (2011), which was a ‘gentleman’s agreement’ between the BoE and the UK’s biggest lenders, RBS, Lloyds, HSBC and Barclays, to lend more money to small businesses and individuals. With lending actually reducing over the past year, Project Merlin has been dismissed as a failure. The difference in this new scheme comes in the way it is structured. With concrete deal terms and the opportunity for banks to receive considerably cheaper money from the BoE if targets are met, banks should be adequately incentivized to step up lending.

The money under the Funding for Lending Scheme will be offered to all large banks, with the cost of the loans based on their ability to continue lending. The cost will be dependent on its net lending between June 30 and the end of 2013. Banks that increase or maintain their lending over that period will pay 0.25% in interest. However, for every 1.00% fall in net lending, the bank will be forced to pay an additional 0.25% interest up to a maximum of 1.50% (still less than the current market price).

It is a measure of the economic quagmire that the UK finds itself in that this new scheme is being delivered in tandem with the Monetary Policy Committee’s decision to expand its asset-purchase facility (quantitative easing) by another £50bn.

The Bank of England’s figures show that the stock of bank loans to the corporate sector peaked in August 2008 at £517bn, but have since fallen by £95bn, a staggering 18%. The theory is that the availability of cheap loans may encourage some firms to take on loans in order to expand their business, especially those that were previously unwilling due to the high price associated with borrowing.

Of course there is some skepticism towards the scheme, the most notable being that banks may not pass on the cheaper lending, instead pocketing the cheap money, despite the higher costs that this would incur. Moreover, we are right to question whether withering bank lending is indeed a major factor behind the current recession. Is there really demand for loans? Are UK businesses really targeting expansion in the current climate? Or are companies just content to cautiously weather the storm and wait for friendlier economic conditions before they take on debt and with it, risk. Indeed the key drivers of the UK recession lie outside lending; the debt crisis and low consumer confidence to name just two.

Sterling responded positively to the announcement of the Funding for Lending details, with GBP/EUR spiking from €1.2650 to €1.2700, continuing the uptrend this pair has seen this month. Investors were clearly encouraged by the scheme with many believing that this could have a positive impact on the UK economy. Clearly events on the continent are of greater importance, GBP/EUR’s rise has much more to do with euro-weakness than with sterling-strength. Only time will tell whether the BoE’s new scheme will help UK growth pick up in the second half of the year – if it doesn’t you can bank on yet more QE. You can't blame the BoE for trying though, it must be seen to do something to promote growth, particularly amid rising extermal threats from the eurozone.

Adam Highfield
Analyst – Caxton FX
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Caxton FX Weekly Round-Up: More Euro Weakness Ahead

The euro-bashing continues amid delays to the German court ruling

The euro has hit fresh lows against the dollar and the pound in the past week thanks to further declines in US stocks, widening peripheral bond yields and heightened eurozone concerns.

Germany’s constitutional court has decided to wait until September to give its ruling on whether the changes to the European Stability Mechanism and the fiscal compact are legal according to German law. This sets back the implementation of the progress made at the EU’s last Summit and ensures a high degree of market uncertainty over the rest of the summer. The decision goes against the pleas from the German government for a swift ruling that would help contain the debt crisis.

ECB President Draghi has tried to calm market tensions, asserting last week that the euro as currency was irreversible, but investors failed to take much comfort. The euro has been unjustifiably high over the past two years given its waning economic fundamentals and soaring debt levels; the euro’s sell-off since early May is the correction that we have had to be very patient in waiting for.

Bank of England ‘Funding for Lending’ scheme impresses

Sterling is benefitting from plenty of safe-haven flows at present, which has seen GBP/EUR hit a fresh 3 ½ month high of €1.2768. There have even been some small pockets of optimism in the UK economy of late; industrial and manufacturing production growth improved in May thanks to shifting the Bank Holiday to June. The UK trade deficit even narrowed significantly in May. Last Friday saw the release of details relating to the Bank of England’s new ‘Funding for Lending’ scheme. UK banks will have access to £80bn worth of cheap loans and will be incentivized to pass this on to UK businesses. The markets responded positively to the programme, which starts in August, and sterling performed strongly. Nevertheless, the market will not kid itself into thinking the UK economy is going to gain much momentum in H2 of 2012.

UK inflation has come right down to a 34-month low of 2.4%, driven by weak domestic activity but this also been helped by the stronger pound. Low inflation clearly supports the MPC’s decision earlier this month to introduce further QE. The minutes from that meeting will be released on Wednesday morning and a unanimous vote in favour of QE could possibly be revealed, at least a strong majority. This shouldn’t weigh on sterling too heavily. UK retail sales data for June should again be positive on Thursday, helped by the Queen’s Diamond Jubilee celebrations.

US Federal Reserve Chairman Bernanke speaks again over the next two days and with data revealing on Monday that US retail sales contracted sharply once again in June, hopes are high for indications that QE3 is imminent. Despite ongoing weakness in US figures, we expect yet more of the same from Bernanke, a dovish tone but reluctance to signal QE3 for the time being.

Sterling is trading at €1.2720 today and continues to look poised for another push higher. The euro’s sell-off looks set to drag on further, particularly in light of the German constitutional court’s decision to delay its decision. At $1.56, sterling is performing strongly against the USD but we don’t see this lasting much longer. EUR/USD should weigh on the GBP/USD but we still see the pound holding up better than the euro.

End of week forecast
GBP / EUR 1.2775
GBP / USD 1.5550
EUR / USD 1.2175
GBP / AUD 1.5275

Richard Driver
Analyst – Caxton FX

For the latest forex news and views, follow us on twitter @caxtonfx and sign up to our daily report.

The Swedish Krona has had a good run but the game could be up

Data has revealed that the Swedish economy took a surprise upturn in the first quarter of this year. This improved domestic economic performance has given the Riksbank the confidence to leave interest rates unchanged for the second consecutive meeting, though there remain calls for another cut within the central bank’s ranks.

A brighter picture in Sweden has coincided with a mild recovery in global equities and risk appetite, in the wake of May’s crisis of eurozone confidence. Greece has managed to form a coalition government and concerns surrounding a messy Greek default and exit from the eurozonehave eased, for the time being at least. Spain’s situation looked capable of spiralling out of control, with the country’s 10-year bond yields setting new euro-area records up above the dangerous 7.0% mark. Some progress has been made with regard to Spain; an agreement has been reached for the bailout of its banks and some unexpected decisions made at the recent EU Summit have eased some short-term concerns.

Whilst market confidence has turned distinctly negative in recent sessions, the positive Swedish data in recent weeks has provided plenty of support for the Swedish krona, suggestive of a strong second half of the year for the Swedish economy. However, we view the risks to market sentiment and developments in the debt crisis to be heavily skewed to the downside. As such we don’t see too much more upside for the krona from here over the next couple of months.

GBP/SEK

After this pair peaked close to 11.50 in mid-May, the krona has rebounded impressively over the past two months. Sterling has struggled against many of the riskier currencies in recent weeks. Global stocks have staged an impressive recovery from their May sell-off and the krona has tracked that bounce inrisk appetite.

Events in the UK have not helped sterling’s cause of late. Growth data has been consistently weak, suggesting there will be no swift bounce back out of the double-dip recession that the UK has found itself in. Data confirmed the UK economy contracted by 0.3% in Q1 and we expect another contraction in UK GDP in Q2. The Bank of England’s response to fading domestic activity has been to introduce yet more quantitative easing, which is of course a negative for the pound. This factor has contributed to GBP/SEK’s poor performance over the past couple of months.

The Riksbank decided to leave its interest rate at the current level of 1.50% in July. Only two votes out of six were in favour of another cut to the Riskbank’s base rate, with the majority satisfied with the upturn in Swedish activity. The Swedish economy grew by 0.8% between Q4 2011 and Q1 2012 and the Riskbank is expecting overall growth of 0.6% this year, up from previous estimates of 0.4%. We have seen some positive figures comes out of Q2 as well;Swedish industrial production rose by an impressive 3.0% in May, while industrial orders rose by 4.5%, which has sparked a good degree of optimism surrounding the Swedish growth outlook.

There remains plenty of reason for caution. Swedish unemployment is rising (up at 4.4% from 4.0%) and the Swedish economy remains very vulnerable to deteriorating eurozone conditions. This second factor will ensure that another interest rate cut later this year is always a possibility, but on balance we expect the Riksbank to hold fire. We don’t see much further downside for this pair and expect a bounce back above the 11.00 mark over the coming weeks.

EUR/SEK

This pair has come under some aggressive selling pressure in the past two months. The risks of economic disaster posed by the eurozone debt crisis are building every monthand this has seen the single currency take another sharp turn for the worse.

The short-term risks posed by Greece have eased now that a coalition government is in place but when the bailout term negotiations commence there is plenty of scope for alarm bells. Concerns over Spain have more than stepped in to fill the void; its banking sector has had to seek a bailout and despite significant progress at the recent EU Summit, Spanish bond yields remain dangerously close to 7.0%.

Investors are still sceptical towards the euro and rightly so – no long-term solution is in sight; the bailout funds are still insufficient, Germany continues to obstruct the introduction of Eurobonds, peripheral borrowing costs remain high and eurozone growth is contracting. Even the progress made at the recent EU Summit has been placed in doubt by the German constitutional court delaying ratification of the ESM changes and the fiscal pact. In addition, the euro’s yield differential has once again been reduced by a 0.25% ECB interest rate cut (to 0.75%) this month, with further monetary easing in the form of another rate cut or cheap loan offering likely this summer.

With the euro losing ground across the board, the SEK is shining out as a safer European alternative backed by stable domestic economic growth and low debt levels. There are plenty of rumours that the SEK is a popular target with the Swiss National Bank as it continues its project of recycling the euros it acquires whilst weakening the CHF.

This pair is trading at an 11 ½ half year low; whilst we do not expect any major progress in the eurozone over the next couple of months, we do expect to see this pair to benefit from a minor bounce after its sharp recent decline. The SEK remains vulnerable to major panic in the eurozone. A bounce up towards 8.80 over the coming weeks looks a good bet.

USD/SEK

As one of the safest currencies available, the US dollar has been a strong performer since early May, which has helped this pair continue the uptrend that has played out over the past year. Eurozone fears have reached new heights and the safe-haven dollar always strengthens in this environment.

The US dollar has not been without its own domestic issues though; the US economy slowed down sharplyover the first half of 2012, the Q1 GDP figure was revised down to 1.9% (y/y) from 2.2%. Consistently soft figures out of the US labour market in particular have ramped up speculation that the US Federal Reserve will announce a third round of quantitative easing (QE3). Regardless of the risks of QE3 this year though, we envisage enough safe-haven demand for the dollar to outperform.

We envisage plenty more gains for the US dollar in the second half of this year, with USD/SEK heading back up towards it recent highs around 7.30 in the coming few weeks, with fresh highs above 7.50 likely towards the end of Q3.

NOK/SEK

The Norwegian economy continues to shine, having grown by 1.1% in the first quarter of this year. The latest updates in terms of Norwegian manufacturing and industrial production were positive and retail sales growth was particularly impressive in May. There is no doubt that the Norwegian economy is proving extremely resilient to the global and eurozone economic downturn that has developed this year. Rising investment in Norway’s lucrative oil sector is providing steady support to growth and with forward-looking economic surveys looking positive;the Norges Bank has revised its GDP forecasts upward to 3.75% from 3.25% for 2012.

Clearly the Norges Bank has been eager to highlight the external threats to the Norwegian economy, most notably from the eurozone debt crisis. Indeed it stated in June that “turbulence and weak growth prospects abroad suggest the key policy rate should be kept on hold.”However, the Norges Bank is one of the few global central banks not inclined towards easier monetary policy and we currently expect an interest rate hike from the Norges bank around the turn of 2013. Of course, this will be highly sensitive to developments in the eurozone and how drastically this affects Norwegian exports.

The Norwegian krone is still a commodity currency and although Norway’s strong economic fundamentals have to a large extent offset the effects of declining oil prices on the krone, the slide has still weighed on the currency. Since the uncertainty triggered by the Greek elections in early May, the price of Brent crude has declined by almost 20% from $120 to under $100 per barrel.

This factor has contributed to a sharp downward correction in the NOK/SEK rate, dragging it down from two-year highs above 1.20 to current levels just above 1.14. We consider these levels to be much too low and are confident that we will see a strong bounce off these lows up towards 1.18 over the next few weeks.

Richard Driver
Analyst – Caxton FX

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Caxton FX Weekly Round-up: Euro takes a hammering

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
For the latest forex news and views, follow us on twitter @caxtonfx and sign up to our daily report.

Euro drops on the back of central bank action

This Thursday (5, July 2012) saw the Bank of England announce that it would be increasing its quantitative easing (QE) programme by £50bn, taking the total QE to £375bn. However, the lack of movement in the markets suggest that it was fully priced in.

The market moving news from yesterday was of course the European Central Bank (ECB) announcement to cut rates, with the main refinancing rate cut to 0.75% and the deposit rate to 0%, both down 25 basis points. The rate cuts were as expected but the markets took a fairly dim view on the action taken. Trading was volatile and the GBP/EUR rose from 1.244 to 1.254 in the wake of the announcement, now pushing its three-and-a-half year high.

The cutting of the deposit rate is designed to encourage banks to lend as they would now receive no interest on money deposited with the ECB overnight. Mario Draghi said in his statement that the eurozone was likely to show little or no growth and his downbeat outlook did not help the euro or those countries that have been struggling of late.

Spanish 10-year bonds have today reached levels over 7% and threaten to rise higher. 7% and above is considered by many as a dangerous, as well as an unsustainable level of borrowing costs, and was the level at which other countries, such as Ireland, had to request a bailout.

We also saw a surprise interest rate cut from the People’s Bank of China, an indication that growth in the world's second largest economy is slowing more than Beijing had previously expected. The last time the People’s Bank of China cut interest rates was shortly before poor economic data was released, maintaining its strategy of acting pre-emptively ahead of poor data. This most recent cut comes a week before a range of Chinese economic figures are due to be announced, possibly indicating a retracement in growth.

All eyes now turn to today’s announcement of US non-farm employment data due out at 1.30pm. Forecasts anticipate the data to show the number of people in employment grew to 97,000 this month, rising from 69,000 previously.

A positive announcement could lead the US dollar to be investors’ choice of currency and boost demand for the greenback, with traders lodging positions for the weekend. Should the data be worse than expected, we may also see currency flows toward the greenback, as investors become wary of the global economic condition and seek shelter with the relatively-safe US dollar.

The news will also have an impact on a number of other currencies, including the Aussie dollar and New Zealand dollar, with investors' risk appetite heavily reliant on US economic indicators.

Adam Highfield 
Analyst, Caxton FX