Rabobank FX: EUR in the doghouseBy Jane Foley | 16 May 2011, 11:56 BST
Jane Foley,Senior Currency Strategist, Rabobank International
The arrest of the IMF Chief at the weekend has been taken by the market as adding another element of uncertainty into the outlook for risk.
Although the IMF is playing a key part in the peripheral bail-outs, it is unlikely that this incident will obstruct the progress made in either the Portuguese or Greece packages. The Portuguese situation is scheduled to take centre stage during today's EU Finance Ministers meeting.
Approval of a bail-out is widely expected to be given; the bond market is awaiting to see whether or not the interest rate tied to the loan can be viewed as punitive or not. This issue will be of prime interest to the Irish who have been pressuring for a reduction in their cost of borrowing although this is not a topic on the agenda for this week's meetings.
Greece is also expected to officially ask for an increase to its EUR 100 bln bail-out this week; an event which is general viewed as inevitable given Greece's untenable fiscal situation. The signing off of a package for Portugal may offer some comfort for the EUR, though there would be little surprise in such an event.
In any event the EUR is unlikely to celebrate the signing off of a new bail-out package in the way it did after the Greek plan last summer. The market had thought that bail-out packages were supposed to draw a line under a country's fiscal difficulties. One year on from Greece's plan and the market is debating the possibilities of eventual restructuring. As a consequence the EUR is set to remain vulnerable.
Interest rate differentials, however, may offer the EUR some support this week. While concerns surrounding sovereign debt default rather than interest rate differentials have clearly won the upper hand over EUR/USD, rate spreads have been moving further in favour of the EUR.
The better than expected GDP data from Germany on Friday served as a reminder of why the ECB is vigilant on inflation. This morning the market is expecting Eurozone April CPI to register another elevated 2.8% y/y headline figure in April.
This should reassert the risk that the ECB may again hike interest rates in July and use its June meeting to signal this. Interest rate differentials suggest that EUR/USD has the potential to drift higher. Cloud base at EUR/USD1.3958 likely to offer strong support ahead of 100 day sma at USD1.3923.
GBP, a busy week ahead
The release of the MPC minutes, CPI, retail sales and jobs data define a busy week for sterling. In our view the gains in the pound made on the back of the Inflation Report leave sterling vulnerable to weak economic data and dovish minutes.
However, downside may be limited. Last week there were signs that the pound was being treated as a diversification trade as a consequence of the pressure on the EUR. In terms of its growth outlook, UK fundamentals leave a lot to be desired.
However, the gilts market appears to have drawn some support over the past year from the government's 'no nonsense' approach in addressing the fiscal deficit and it follows that in time sterling may also see a visible reward from fiscal retrenchment.
Even though last week's sterling's 'diversification' gains were likely more a function of the crowded nature of the CHF long positions than they were about UK fundamentals, sterling may find itself well supported if the EUR remains in the dog-house.
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