Euro: Why the ECB Will Not Cut Rates Until 2009

[DailyFx]

The euro consolidated above 1.41 towards the end of the US trading session on Tuesday, as the US dollar remains relatively strong across the majors, but like the British pound, there are technical indications that EUR/USD could advance.



Meanwhile, from a fundamental perspective, much of the EUR/USD decline has been due to speculation that the European Central Bank will cut rates while the Federal Reserve will hike. Last week, we saw the ECB leave rates unchanged at 4.25 percent, and as expected, ECB President Trichet remained hawkish on inflation and somewhat bearish on economic prospects, especially since ECB staff projections for growth were revised down for 2008 and 2009. Overall, though, ECB voting members remain focused on their primary mandate of price stability, suggesting the 25-50bps worth of cuts expected during the next 12 months will not occur until 2009. If this starts to become clear to the markets, the euro may finally have the fundamental impetus to recover.

Yesterday I said that the US dollar rally stemming from the Fannie Mae/Freddie Mac news was one to be leery of, and I still believe that to be the case. Indeed, according to COT forex positioning, the dollar is extremely overbought, suggesting we may be nearing a point where risk/reward warrants selling the greenback. We’ve seen some incredibly volatility in the currency, as the EUR/USD and GBP/USD pairs traded in more than 100 pip ranges. When it comes down to it though, the dollar still ended Tuesday up very slightly versus most of the majors (though it fell against the Japanese yen). Looking at the economic data on hand, US pending home sales fell 3.2 percent, as fewer Americans signed contracts to buy homes. Such a decline is not incredibly surprising, as demand for homes remains extremely weak given the US economic slowdown and more stringent lending standards. Meanwhile, wholesale inventories rocketed 1.4 percent in July while wholesales sales slipped 0.3 percent, suggesting that lackluster demand is leaving firms stuck with excess supplies. This does not bode well for this Friday’s advance retail sales release, especially given the continued deterioration in the US labor markets as indicated by last week’s US non-farm payrolls (NFPs) report.


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