Euro Weakness Persists - Will ECB Follow the Fed?

[B]Talking Points

• Japanese Yen: Firmer as risk aversion reigns in Asia
• Euro: Weakness persists as short term rates fall
• British Pound: Capped at 1.9600 ahead of the BoE
• US Dollar: Non Farm productivity on tap[/B]

It was another night of euro selling in the currency market in a generally quiet session marked by absence of any meaningful economic data on the calendar in both the EZ and UK. The EURUSD continues to be affected by rising waves of risk aversion and growing market consensus that ECB will have to change its hawkish course and follow the Fed down the path of more accommodative monetary policy.

In the wake of yesterday -370 point collapse in the Dow, the Nikkei fell another -640 points and the equity price action dragged down the EURJPY cross as well as many of the high yielders such as the Australian dollar. However, by the time European bourses opened for trade much of the appetite for risk liquidation disappeared and both Footsie and DAX remained positive on the day. The performance of the European stock markets helped to stabilize the EURUSD and the pair found support at the 1.4600 figure for most of early European trade.

However, with short term Euribor rates now at their lowest level since August, the euro is likely to feel more selling pressure for the rest of the week. The focus in the currency market appears to have shifted from concern over the contraction of the US economy to anticipating a serious slowdown in economic activity in the Euro-zone. As we state in out special report Why Is The Dollar So Strong? , while the fundamental arguments for EURUSD strength are numerous, the price action has not supported a euro-bullish thesis.

Meanwhile in UK the BRC shop index rose at only 1.2% annual rate, suggesting that price pressures are beginning to ease, leaving the BoE with ample room to lower rates. While many traders were initially fearful of a possible 50bp cut, the UK monetary officials are much more likely to be opt for a more conservative 25bp choice. In fact, former BoE MPC member Stephen Nickell opined that there is a “zero” chance of a 50bp rate cut tomorrow.

Much of the price action in the pound will depend on the post announcement statement by the BoE. If UK monetary authorities indicate that further rate cuts are likely, cable may weaken, but if they adopt a “wait and see” approach to any additional easing sterling may bounce despite the lowering of rates. Given the relatively healthy results of the latest UK PMI Services number, the BoE is unlikely to sound the alarm just yet.

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[B]To discuss this article please contact Boris Schlossberg, Senior Curency Strategist: [/B][email protected]