Sunday, March 8, 2009

10.1 UK banking fiasco could push euro to strengthen against sterling

Last week's wrap:
The euro opened the week by gapping down with the on-going atmosphere of risk aversion, disappointment over the non-event that was the European crisis summit and anticipation of an almost certain ECB rate cut on Thursday all adding to euro weakness.

The Reserve Bank of Australia’s decision to hold interest rates at 3.25% early on Tuesday surprised many and led to a temporary respite in risk aversion. This buoyed the euro, which tested 1.2675 before falling back in the opening hours of London trading. The Bank of Canada struck a less optimistic note later the same day. The central bank cut its rates 50 bps to 0.50% and hinted it would provide additional financial stimulus through credit and quantitative easing if required. This Canadian caution seems justified. Terrible US housing data brought further downside pressure onto the 16-nation unit and, when Australian GDP came in at -0.5%, EUR/USD hit its week low at 1.2456. The euro recovered as China’s official PMI saw manufacturing in the People’s Republic grow for the third month running. However, when a much-anticipated announcement of a fresh stimulus package from the Chinese government failed to materialize, the euro started the march south once more. Thursday’s run up to the ECB’s interest rate announcement saw more bad news out of the European powerhouse as German retail sales fell unexpectedly. The ECB cut by 50bps to 1.50% as expected and when the bank’s president, Jean-Claude Trichet, would not rule out further cuts the euro fell to 1.2480. However, the bank now seems to accept the urgency of the situation and expressed its readiness to act, so the euro could (just could) be turning the corner. Friday was NFP day. The data showed that US employers had cut more jobs than expected and the unemployment rate rose to a 25-year high. Nevertheless. although you might expect the dollar to strengthen on risk aversion, EUR/USD leapt above 1.27 during the hour after the publication of the numbers. Bloomberg put the rise down to the fact the pace of the cuts was slowing down, but perhaps it marks a shift in underlying dollar sentiment – only time will tell. The euro went on to weaken as the US session progressed and closed the week at 1.2634.

Sterling spent the week ranging between 1.43 and 1.40 and essentially tracked the euro’s ups and downs. GBP/USD fell to 1.3983 to reconfirm strong support at 1.40, on the release of Australia’s disappointing Q4 GDP. Thursday saw the Bank of England cut rates 50bps to 0.50% as expected with the central bank promising that it would now boost the money supply in a bid to revive the economy. Although the UK media widely misinterpreted this as a bid to print money, cable found support at 1.4050 after the news and then went on to recover. The pair tested 1.43 immediately after Friday’s US job numbers before closing the week at 1.4070. News broke on Saturday that the UK government is going to underwrite £260B of Lloyd TSB’s risky assets. This move will give the British government a 75% stake in the group and would not have been necessary if the bank had resisted government pressure to merge with stricken bank HBOS last September. It looks like sterling is in for a rocky ride this coming week.

Calendar notes
It promises to be a relatively quiet week in terms of economic data.

US: Tuesday sees Fed Chairman Ben Bernanke delivering a speech about financial reform. There’s the federal government budget balance on Wednesday, while Thursday has retail sales numbers and new unemployment claims lined up. Friday brings the US trade balance and the University of Michigan’s preliminary consumer sentiment.
Euro-zone: Expect important data out of Germany including the trade balance on Tuesday, producer price inflation and factory orders on Wednesday and industrial production on Thursday. The ECB monthly bulletin is also released on Thursday as is the euro-zone’s PPI. Friday 13th sees EZ retail sales.
UK: Retail sales and house price numbers kick things off for the UK in the early hours of Tuesday. The trade balance will be released on Wednesday.
Japan: Keep your eye out for Japan’s final GDP, which is expected to be revised down.
Switzerland: The Swiss National Bank is expected to cut rates another 25bps to 0.25% on Thursday afternoon.
New Zealand: The Reserve Bank of New Zealand is expected to cut its interest rates 75bps to 2.75%.

EUR/USD support: 1.2330; resistance: 1.2730 with an upside breakout seeing further resistance at 1.2830.
GBP/USD: support 1.3525; resistance 1.4300
USD/JPY: support 94.50; resistance: 99.70

EUR/GBP: The Lloyds TSB fiasco could well push this pair to an upside breakout of 0.9000. You’ll find some technical background on this here.

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