Euro advances on speculation for further easing

Talking Points

  • Japanese yen: Weighed by rebound in risk appetite
  • British pound: Halts longest losing streak since 2008
  • Euro: German retail sales jumps in October
  • U.S. dollar: ISM manufacturing, Fed’s Beige Book on tap

The Euro advanced to a high of 1.3135 on speculation that the European Central Bank will expand its asset purchase program in order to stem the risks for contagion, and the single-currency may continue to recoup the losses from earlier this week as risk appetite flows back into the market. With the ECB scheduled to announce its interest rate decision tomorrow at 12:45 GMT, we expect President Trichet to talk down the risks for the region as fears surrounding the European debt crisis intensifies, and the central bank head may see scope to expand monetary policy further as policy makers struggle to restore investor confidence. As a result, the EUR/USD is likely to face increased volatility over the next 24 hours of trading, but the lack of momentum to hold above the 200-Day SMA at 1.3124 could keep the exchange rate within a narrow range throughout the day as investors weigh the prospects for future policy.

However, the relief rally in the euro could be short-lived as market participants expect Portugal and Spain to share Ireland’s ill fate, and the Governing Council may look to keep its exit strategy on hold throughout the beginning of the following year as the economic outlook remains clouded with uncertainties. Nevertheless, the economic docket showed retail spending in Germany increased 2.3% in October to top expectations for a 1.2% rise, while manufacturing in Europe’s largest economy expanded at a faster pace in November, with the PMI reading advancing to 58.1 from 56.6 in the previous month. As the recovery gradually gathers pace, some members of the ECB may push to withdraw monetary support in order to contain inflation, but the ongoing slack within the real economy could spur mixed opinions within the central bank as policy makers expect to see an “uneven” recovery going forward.

The British Pound halted the longest losing streak since 2008 as the exchange rate rallied to a high of 1.5648 during the European trade, but the GBP/USD may hold below the 100-Day SMA (1.5714) throughout the day as U.K. policy makers come under scrutiny. According to a report on WikiLeaks, Bank of England Governor Mervyn King said Prime Minister David Cameron and Chancellor of the Exchequer George Osborne’s “lack of experience” will make it increasingly difficult for the new coalition to manage fiscal policy, and went onto say that the two have “not fully grasped” the challenges they face as they take unprecedented steps to balance the budget deficit. As the government plans to curb public spending and withdraw fiscal support, there could be increased pressures on the BoE to support the real economy in 2011, and the central bank may preserve its wait-and-see approach throughout the beginning of the following year in order to balance the risks for the region. However, as policy makers expect inflation to hold above the 2% throughout 2011, there could be a growing split within the MPC as the central bank maintains its dual mandate to ensure price stability while promoting full employment.

The greenback weakened against most of its major counterparts on Wednesday as investors raised their appetite for risk, and the dollar may face increased selling pressures during the North American trade as equity futures foreshadow a higher open for the U.S. market. Nevertheless, the ADP employment report is expected to show private payrolls in the U.S. increasing 70K in November after expanding 43K in the previous month, and the data would certainly bode well for Friday’s non-farm payrolls report as market participants expect the U.S. economy to add 145K jobs this month. At the same time, manufacturing in the world’s largest economy is anticipated to expand at a slower pace in November, with the markets forecasting the ISM index to fall back to 56.5 from 56.9 in the month prior, and the mixed batch of data is likely to spur increased volatility in the currency market as investors weigh the outlook for future growth. However, the biggest market mover is likely to be the Fed’s Beige Book economic report, which is due out at 19:00 GMT, and a shift in the central bank’s economic assessment could set the tone for future price action as it embarks on additional monetary easing.

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