The decline is also compatible with lingering uncertainties over the resolution of the debt crisis, that will again be the dominant market theme next week. ..…
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In the event of favourable developments on this front, the euro may start to climb back. The BoE also took an expansive stance, by stepping up the APF and drawing a picture of the UK economy in shades of gray. However, sterling seems better supported and should outperform the euro.
EUR – The ECB has cut rates. Last week we wrote: “On the whole, a refi rate cut could weaken the euro as an immediate impact reaction. In any case, the exchange rate decline is unlikely to extend to the lows hit at the beginning of the month in the 1.22 area, stopping in the 1.23 area at the most”. This proved to be the case: following the ECB’s announcement, the euro dropped to EUR/USD 1.2364, moving from a high of 1.2681 on Monday. We believe the single currency’s reaction is compatible with the economic and market situations. The correction responds both to the narrowing of the interest rate differential, and to lingering uncertainty over the resolution of the debt crisis, as well as to the euro area’s weak macroeconomic outlook, regardless of the crisis. From a purely technical point of view, the breakthrough of 1.2441 aids a reopening of the downside front towards 1.22-1.20. This is the time most prone to a concentration of downside risks. The interest rate cut marks the acknowledgement that there has been an overall deterioration, and that the response to the euro area’s problems still hasn’t been sufficient. Also, for what concerns the debt crisis, the outcome of the European Council summit, while certainly positive, leaves open issues that can no longer be postponed. Therefore, next week will be important in light of the European calendar of events, starting with the Eurogroup meeting on Monday. Positive developments on this front could push the euro back up towards 1.25-1.26. Otherwise, downside of between 1.22 and 1.20 would linger.
GBP – As widely expected, the BoE has expanded the APF, from 325 to 375 billion pounds, although it justified the decision using markedly dovish tones: (1) the growth scenario has deteriorated, (2) inflation has dropped more than expected, (3) the problems faced by the euro area continue to represent a major risk for the UK economy, even after the positive outcome of the European Council summit. The new asset purchase programme will have a duration of four months, but the BoE will keep its amount monitored, i.e. a further expansion cannot be ruled if the situation should worsen. This could expose the pound to some downside, but only against the dollar. This is because we believe that in the present context, a direct comparison between sterling and the euro shows that the UK currency has the capacity to outperform. We think the market has confidence in the programme launched jointly by the BoE and the Treasury to support the economy. On the other hand, there is no such confidence in the euro area, where the perception is that it will not be easy to implement the actions still necessary to solve the crisis. In the present phase – temporary in our view – we therefore think that the EUR/GBP exchange rate may extend and amplify its fluctuations below the EUR/GBP 0.8000 mark.
JPY – The yen stayed broadly stable against the dollar, fluctuating between USD/JPY 79.31 and 80.10, although downside evidently prevailed in the week. However, rather than a weakening of the yen, this was a widespread strengthening of the dollar in response to the expansive measures put in place by the ECB, the BoE and PBoC. The USD/JPY 80.00 mark will stay hard break through autonomously unless further progress is made in resolution of the euro area crisis. However, an intervention does not seem likely, barring a sudden and violent surge in risk aversion. Therefore, the BoJ meeting next week will be under the spotlights.
Appendix
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