Euro falls sharply on Italian election and dismal economic news
04/Mar/2013 • Currency Updates•
In a week where risk assets (except for commodities moved very little, the Euro provided most of the fireworks. The Italian electorate soundly rejected Monti and his disastrous austerity policies, and returned an essentially ungovernable parliament. This news and yet another batch of terrible macroeconomic news from the Eurozone proved too much for the Euro, which ended the week hovering just above the psychological 1.30 level. Sterling was dragged down by the common currency vs. the dollar, but managed to regain its footing against the Euro. FX markets appear to be firmly focused again on macroeconomic fundamental, which bodes ill for the Euro – we expect the 1.30 level to be cracked this week.
Events in the UK point towards a new increase of the Gilt purchase target, which has been our out-of-consensus view all along. Last week, the manufacturing PMI unexpectedly tumbled well into contractionary territory, European data came out even worse than usual, and MPC member Charlie Bean sounded very dovish and suggested that his vote is about to change in the direction of further QE. Another committee member, Tucker, also floated the idea of negative interest rates. Our call is that QE will come either next week or in the April meeting, with about a 50% chance. As for the impact on Sterling, we expect a continuation of last week’s trend, where Sterling dropped sharply against the dollar but rebounded somewhat against the Euro.
Another tough week for the common currency. Italian voters joined those of every nation that has voted on the issue, and soundly rejected its incumbent Government and its austerity policies. The resulting political map in Italy seems to rule out an stable Government, though no doubt the austerians will try find a way to circumvent the will of the Italian electorate.However, no political maneuvering can stop the deterioration of macroeconomic data in Euroland. Following last weeks’ unexpected fall in PMI surveys, and Eurozone unemployment rose to yet another record at 11.9%. We are changing our call for the ECB meeting, and we expect a cut in rates from 0.75% either at next week’s meeting or a month hence. We do not think this measure will have any impact. As the austerity consensus remains as entrenched as ever in Brussels and Berlin, we expect bad news and hence downward pressure on the Euro to continue over the short and medium term.
The lack of agreement between the White House and Congress regarding further deficit reduction brought about the automatic budget cuts known as sequester as of Friday. The cuts will amount to about 0.5% of GDP, which we do not think will suffice to throw the US recovery off course. The housing sector continues to grow strongly; last week reports on home sales, home prices, and new home construction all provided pleasant positive surprises. As long as the labor market holds up, and the European crisis remains in its current chronic, slow moving state, we will maintain our forecast of growth between 2.5% and 3.5% in the US