Although yesterday’s underlying trading volumes were adversely affected by the US Independence Day holiday, nevertheless there was an attempt by some participants to seek out the pain threshold of other players. For most of the day the euro probed for stops around the 1.2550/1.2560 level, only to meet determined buying interest. The latter eventually evaporated, with the euro quickly sliding to a low of 1.2513. The mood towards the single currency was not helped by some more weak economic data in the form of service sector PMIs and eurozone retail sales. Also weighing on the euro slightly was the announcement from Paris that EUR 7.2bln of new taxes would be raised this year to narrow the fiscal deficit due to a shortfall in receipts. The revenue measures include a one-off tax on the wealthy (little wonder many high-earning French nationals are fleeing to friendlier tax jurisdictions such as London), a doubling of the tax on share-trading and a reduction in tax breaks for overtime. For those of a bullish disposition, the hope would be that the euro mounts an attack on the 50d moving average at around 1.27 in coming days. That said, the bears have been in charge so far this week in what has been a disappointing performance in the aftermath of a positive EU Summit.
ECB and the euro. The foundations for an ECB rate cut at today’s meeting look to be firmly in place. Firstly, the ECB President let it be known last month that some members of the Governing Council voted for a rate cut. This is a level of clarity not afforded by the previous incumbents, even though we don’t get data on the numbers or the members’ voting patterns. Secondly, the summit of EU leaders last week made more progress than was generally anticipated. Or to put it another way, there was less implicit pressure on the ECB to cut rates and there is a general rule of thumb that, when the ECB feels pressure from politicians, it is less likely to move. This has been evident pretty much from the start, regardless of who has been President. Finally, the recent run of data since the last meeting, both within the eurozone and beyond, has strengthened the case for lower rates, with the global economy looking less assured and also Germany seeing both lower inflation and softer business sentiment. The impact of an easing on the currency is less clear perhaps. The normally relatively tight correlation between EUR/USD and 2Y interest rate differentials (Germany minus US) broke down in the early part of the year as the impact of the ECB’s 3Y loans program was surpassed by the softer dollar that resulted from relatively better US economic data. More recently, the correlation has been tighter, but also leading to a steadier tone to EUR/USD as expectations of more QE measures in the US (such as the ‘Operation Twist’ extension) have been factored in. If the ECB combines lower rates with more indications of other measures to encourage lending (i.e. discourage depositing money back at the ECB), then there is scope for some of the recent negative sentiment from the sovereign crisis that is directed towards the single currency to be reversed, especially with positioning data (weekly from CFTC) showing short positioning in the euro still relatively stretched.
Cable confusion. Sterling has not been sure whether it is coming or going ahead of today’s MPC meeting where the Bank is sure to expand its asset-purchase program by a further GBP 50bln. Yesterday’s poor services sector PMI was another nail in the coffin for any remaining policy hawks. In addition, the inflation prognosis is less troubling these days – the BRC reported yesterday that shop prices rose by just 1.1% over the year to June, the lowest since late 2009. Cable meanwhile has been stuck in an extremely tight trading range for the past four weeks, bounded almost exclusively by 1.55 below and 1.57 above. Sterling still appears to have a body of potential buying support at lower levels, as witnessed on many occasions already this year. Should the US economy wobble further over coming weeks we are likely to see cable eventually break through the topside of this range.