Eurozone contagion shows signs of taking hold of global economic growth

Tom Tong13/Jul/2012Currency Updates

USD

Yesterday the dollar continued to strengthen against most of its major rivals following FOMC minutes released late on Wednesday. These minutes suggested further quantitative easing was not imminent, which was a contrast to counterpart central banks around the world. However, probably most striking from the minutes, which has put a dent in risk sentiment for investors, is that the committee seems to have no agreed consensus view on what the Fed should do next.

This continuing fall in risk sentiment has seen continued safe haven demand for the dollar against riskier currencies, such as the euro, with EUR/USD reaching 2 year lows.

Additionally, FOMC members were more bearish on GDP growth than they were in April, also cutting their projections for inflation.

Global growth concerns took another large hit this morning as China, the world’s second largest economy, posted GDP growth of 7.6%, a steep decline from previous growth figures of 8.1%, and its slowest in over three years.

All of this gloom succeeded in overshadowing some positive news from the US labour market, where initial jobless claims fell 26,000 to 350,000. This failed to provide any relief to markets, as analysts have suggested this decline was down to fewer simmer shutdowns in the automotive industry than usual.

EUR

The euro yesterday hit fresh 2-year lows as the currency continued to face stiff downward pressure after last week’s rate cuts by the European Central Bank. The euro extended its losing streak after last week’s cut of headline rates by 0.25% and, just as crucially, cut of the deposit rates it pays to European banks to 0%.

Concerns have risen over whether these cuts in interest rates will have the desired effect of increased lending liquidity, as banks’ net deposits within the ECB have remained unchanged.

Over the past week we have seen the euro separate itself from wider financial markets, as the single currency has continued to fall despite Italian borrowing costs falling at an auction yesterday. This suggests that we are now seeing structural outflows out of Europe.

The euro also suffered from the continued gloom of global growth, as China showed particular slowdown. Additionally, the Bank of Korea surprised markets by cutting its base interest rate to 3%, blaming significant downside risks to growth. Weak Australian employment data, interest rate cuts in Brazil, and the Bank of Japan’s adjusting of its asset purchase programme further bolstered this view that the eurozone debt crisis is having a knock on effect on global growth, with many major economies showing signs that their economies are continuing to stall.

Compounding the plight of the euro, early this morning Moody’s further cut Italy’s credit rating (although this would not have been any great surprise to markets).

GBP

Sterling continues to act as a low-beta version for the euro, hovering near 3-1/2 year highs against the single currency, but continuing its decline versus the dollar reaching five-week lows against the US currency.

This week’s soft retail and housing data show that the officially shrinking economy remains fragile at best. However, the pound has been a beneficiary of capital flows from investors fleeing Europe.

Investors have continued to pour money into UK gilts. Given the state of the eurozone, these flows look unlikely to end soon, so there may be more mileage in the gbp/eur trend.

Sterling has benefited in recent months from being seen as a safe haven alternative to the eurozone’s fiscal turmoil, although some market players said the gloomy outlook for the UK economy could limit the pound’s gains. The UK economy remains strongly linked to the fate of the eurozone, thus limiting the relative safe haven appeal of the UK currency.

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Written by Tom Tong

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