Euro ends the week flat as Ireland appears to give in to Euro demands

Tom Tong22/Nov/2010Currency Updates

The generalized correction in financial assets that started the previous week continued into the early part of this week, but then proceeded to lose momentum starting Thursday. The catalyst for the stabilization and rebound of currencies, equities and commodities appeared to be the realization that Ireland was about to give in to EU demands that it seek external help to bail out its troubled banks. This positive news, that appeared to receive further confirmation over the weekend, allowed currencies to rally against the USD with the conspicuous exception of the Japanese yen. Equities ended the week nearly unchanged, while commodities posted modest advances.

GBP

Conflicting signals emerged last week as to the health of British economy and internal demand. Inflation once again surprised slightly to the upside, and it was once again dismissed as a result of temporary factors by the Bank of England. The minutes of the last rate setting meeting of the MPC were published, but contain almost no new information regarding the vote split in the Committee (seven voted to leave rates and the size of the balance sheet unchanged, one voted for a rate hike, one for additional expansion of the balance sheet) or the Bank of England outlook on inflation and the economic recovery. Meanwhile, the Rightmove index of house prices offered further confirmation that the modest rebound in UK house prices is over.

Although the GBP is showing little personality of its own lately and is content to follow the euro moves against the US dollar, we fail to see how the draconian austerity package that will start hitting the British economy in the next few quarter can be a positive for sterling. Therefore, we are happy to maintain a bearish stance on GBP against all currencies save for the euro.

EUR

The direct link between the common currency and the fate of its weaker members has by now been firmly re-established. News swirled all week about the imminence of an Irish application for aid. Ireland appeared to be resisting, arguing that its financial position as a sovereign is covered until mid-2011. If its banks need aid, as they do, then they should be helped independently, particularly since most of their creditors are foreign. EU officials, by contrast, argued that it is the Irish sovereign that must bail out its banks, therefore lending its guarantee to the rescue.

By the weekend it had become clear that Irish resistance was collapsing. Sunday night Ireland announced that it had solicited a bailout package in an amount yet to be decided, which it will proceed to use to shore up its banks.

Like peripheral spreads, the euro ended the week more or less where it began. All eyes now turn to Portugal, where fresh questions have arisen as to the reliability of its debt and deficit figures, and, of course, Spain.

USD

The pattern of better than expected macroeconomic news continued last week, as retail sales surprised to the upside and indicated a healthier than expected level of consumer demand. However, this outperformance was ignored by Forex traders, which continued to be thoroughly fixed on the news coming out of the peripheral countries – in particular Ireland and Portugal. Continued mixed statements out of Fed officials on the likelihood that the QEII programme will be carried out to the full $600 billion did little to clarify matters, and the USD flopped around all week to end up slightly less than 0.5% in trade-weighted terms.

Other G10

The Japanese yen spent last week drifting downwards against the greenback, helped along the way by the continuing back up in US interest rates. An upside surprise in third-quarter Japanese GDP was of no help to the JPY; this, however, is no surprise, as it has been many months since the yen reacted in any meaningful way to domestic macroeconomic news. We see at this point no reason to change our bearish view of the JPY.

Dollar bloc currencies traded in sharply divergent patterns last week. While the Australian dollar followed commodities and equities to end the week essentially flat, the New Zealand dollar was buoyed by a better than expected retail sales report and shook off negative comments from the Central Bank to end the week up nearly 1%. Meanwhile, the Canadian dollar struggled throughout the week, perhaps weighted down by the Canadian Government decision to ban the purchase of Potash by BHP to end down about 0.5%. We continue to note that the cross rate between AUD and NZD is out of line with fundamentals at 1.2670 or so, and see relative value in the Australian dollar vs. the New Zealand dollar.

Next week

All eyes will still be focused on the Irish bailout package and its effect on the bonds of other peripheral sovereigns. Also of note will be US capital goods orders, European sentiment indices, revisions to UK third-quarter GDP and the Bank of Canada meeting.

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Written by Tom Tong

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