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2014 may start badly for the euro if more weak economic data pushes the ECB towards further monetary easing

Publication date: 11 December 2013
Author: Nawaz Ali, Western Union Business Solutions

“The euro has opened strongly, giving British exporters another opportunity to consider their long-term exposure. 2014 may start badly for the euro if more weak economic data pushes the ECB towards further monetary easing.”

Overview

The US dollar fell to new lows against the euro and British pound on Tuesday as many investors continue to remain optimistic that the Federal Reserve is still months away from reducing its $85bn-a-month of bond purchases. However, should the Fed uncover a tapering plan as early as its meeting next week, the US dollar will almost certainly rally into year-end and recover a significant portion of its recent losses.

The euro remains elevated despite some disappointing economic data from Europe this week, increasing the likelihood that central bankers in Europe may start sounding the alarm about the euro’s export-damaging strength. Despite the European Central Bank’s dovish monetary policy outlook and the risk of inflation in the euro zone falling even further, the euro is likely finding short-term support from both risk taking and bank repatriation flows.

The British pound registered fresh 2-year highs against the US dollar yesterday after data on UK manufacturing and industrial output was positive, underlining Britain’s much-improved economic outlook. Bank of England member Martin Weale will be speaking today and after Governor Mark Carney’s remarks earlier this week about currency, Weale could hint that Britain’s currency is starting to look uncomfortably high.

Both the New Zealand and Australian dollars could see some unexpected swings tonight if the Reserve Bank of New Zealand makes further comments about currency intervention alongside its monetary policy decision. The Swiss franc could also create some volatility between the major currencies tomorrow when the Swiss National Bank will announce its latest decision on the country’s currency peg against the euro.

Currency Updates

 


 Sterling

The British pound registered fresh 2-year highs against the US dollar yesterday after data on UK manufacturing and industrial output was positive, underlining Britain’s much-improved economic outlook. Industrial output, the broader of the two measures, rose 0.4% in October against forecasts of a 0.3% month-on-month gain. Production increased by 0.9% in the previous month while a survey from RICS earlier this week showed UK house prices rising in November at their fastest pace in 14 years. The numbers should keep intact speculation that the Bank of England will have to start tightening monetary policy sooner than it expects which is bullish for sterling. However, the pound’s recent rally appears to be losing steam ahead of the holiday break as it continually runs into tough technical barriers where a number of orders to sell the UK currency are clustered on the view that sterling has risen too fast too soon. BoE member Martin Weale will be speaking today and after Governor Mark Carney’s remarks earlier this week about currency, Weale could hint that Britain’s currency is starting to look uncomfortably high.


 US Dollar

Continued debate about the timing of the Federal Reserve’s stimulus taper caused the US dollar to slip broadly yesterday to new 6-week lows against the euro and to its weakest in two years versus the British pound and Swiss franc. Traders largely ignored comments from Fed officials earlier this week who kept alive the chances of a taper as soon as next Wednesday, choosing instead to push US equities to new highs and the US dollar down against its higher-yielding rivals on prospects of loose US monetary policy for longer. Last week’s US non-farm payrolls was taken as positive for risk but not strong enough for the Fed to start reducing its bond purchases as early as next week. Although many in the market expect tapering to come soon, not all market participants expect it to happen at the Fed’s December gathering amid concerns about looming US budget deadlines. Therefore, should the Fed uncover its tapering plan next week, the US dollar will almost certainly rally into year-end and recover a significant portion of its recent losses.

 
 Euro

The euro touched another new 6-week high against the US dollar on Tuesday despite mixed economic data and has moved higher against sterling this morning, increasing the likelihood that central bankers in Europe may start sounding the alarm about the euro’s export-damaging strength. Despite the European Central Bank’s dovish monetary policy outlook and the risk of inflation in the euro zone falling even further, the euro is likely finding short-term support on both risk taking and repatriation flows. A number of banks in the euro zone are bolstering their accounts ahead of the ECB’s Asset Quality Review and bank stress tests, increasing demand for the euro before year-end. However, the ECB may choose to respond, as they have done in the past, to continued euro gains which would further complicate the region’s fragile economic recovery. Furthermore, the euro will probably face increasing pressure next year if, as expected, the US Federal Reserve moves towards less monetary easing while the ECB continues to assess whether or not it needs to do more with policy to support growth.