Greece recapitalise major banks as EU summit continues, whilst UK inflation figures drop paving the way for further QE

Tom Tong23/May/2012Currency Updates

GBP

Sterling fell against the dollar and the euro on Tuesday after UK inflation was softer than expected, bringing back speculation that the Bank of England could ease monetary policy in the coming months to support a flagging economy. The currency’s losses gathered pace after the International Monetary Fund (IMF) announced that the BoE would have to do more quantitative easing (QE) and warned of dangers to the UK economy from an escalation of the eurozone crisis. Official data showed consumer price inflation eased to 3.0 percent in April from 3.5 percent in March, beating expectations of a 3.1 percent rise. Separate figures showed Britain’s public finances posted a record surplus in April, a strong start to the new financial year.

The focus, though, was on the softer-than-expected inflation reading, especially after a Bank of England inflation report last week warned of the risk to UK growth from the eurozone crisis and left the door open for another round of asset purchases.

Stubborn inflation pressures, on the other hand, would make the BoE’s job of easing monetary policy much harder. The eurozone is Britain’s biggest trading partner and UK banks have a sizeable exposure to the region making the economy vulnerable to the debt crisis. The UK is already in recession and retail sales data along with the second reading of first quarter gross domestic product (GDP) on Thursday are likely to confirm how sluggish demand is in the economy. However, the Bank of England Minutes due out this morning may continue to show a 8-1 split amid the stickiness in underlying price growth, and the central bank may have a hard time pushing through more quantitative easing as its credibility to ensure price stability comes under scrutiny. As the relative strength index on GBP/USD continues to hold above oversold territory, the pound-dollar appears to be carving out a short-term base going into the end of May, and we will need a less dovish statement from the BoE to see a meaningful correction in the days ahead.

EUR

The euro fell against the dollar on Tuesday after two days of gains as investors pared back expectations that an informal meeting of European leaders would yield much progress in tackling the region’s debt crisis. However, given the market’s stretched bearish positioning and oversold signals on the technical charts, the euro could see a short-term squeeze higher ahead of the European summit. While there have been hopes in some quarters that today’s summit may lead to agreement on measures to boost growth, investors were not confident of a breakthrough given apparent differences in opinion between Germany and France. French President Francois Hollande is expected to push for a joint eurozone bond, a measure backed by Italy, Spain, and the European Commission. However Germany, Europe’s largest economy and paymaster, has so far opposed the move and continues to champion austerity measures. A German official said on Tuesday that eurobonds did not offer a solution to the region’s problems. The euro closed yesterday as markets await the outcome of today’s EU summit at which growth provisions are expected. There is no doubt that in Brussels, Germany and France will clash over eurobonds.

The Greek Anti-austerity party Syriza’s leader, Alexis Tsipras, said in Berlin yesterday that Greece would remain in the Eurozone if the radical left were to win upcoming elections. With all eyes on the election, the second to take place in just six weeks, the Syriza party is tipped to do better than its second place finish in May 6th polls, which is leaning towards a massive EU-IMF bailout. Further, last night the Greek government agreed to inject €18bn into four of the country’s largest banks to allow recapitalisation. This is in a bid to put the banks in line with capital requirements, which would then allow it to receive funding from the ECB again.

USD

According to JPMorgan Chase, the dollar is expected to strengthen against all its major currencies except the yen over fears of a possible Greek exit from the euro and economic slowdowns in China and the U.S. This has already been the cause of the safe haven dollar’s climb to a 20-month high against a basket of currencies on Tuesday , whilst in comparison, the single currency which was pinned to near a recent four-month low. Despite gains for the dollar, it fell against the yen on Tuesday in Asia as the Bank of Japan’s cautious stance, which disappointed some short term traders who has planned for a surprise monetary easing.

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Written by Tom Tong

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