Bearish Euro Formation In Play, Sterling Outlook Hinges On BoE

By David Song, Currency Analyst

Talking Points
  • Euro: Spanish 10-Year Yield Top 6%, ECB Under Pressure To Ease Further
  • British Pound: BoE To Maintain Current Policy, Inflation Report On Horizon
  • U.S. Dollar: Index Approaching 10,000, Fed Rhetoric In Focus

Euro: Spanish 10-Year Yield Top 6%, ECB Under Pressure To Ease Further

The Euro tumbled to fresh monthly low of 1.2934 amid heightening fears surrounding Spain's banking sector, while the yield tied to the region’s 10-Year debt breached 6%, fueling speculation that Spain will ultimately seek a bailout as it struggles to tap the financial markets. At the same time, the deadlock in Greece continues to instill a bearish outlook for the single currency as the region remains far from form a new coalition, and it seems as though the governments operating under the single currency are becoming increasingly reliant on monetary support as the EU maintains a reactionary approach in addressing the sovereign debt crisis.

European Union Economic and Monetary Affairs Commissioner Olli Rehn talked up the ECB’s role and said there is no ‘ contradiction in terms of further developing the role of the euro system in ensuring financial stability while at the same time guaranteeing price stability ,’ and the Governing Council is likely to face increased pressure to shore up the ailing economy as it remains at risk of a prolonged recession. In turn, we should see the ECB carry its easing cycle into the second-half of the year, and President Mario Draghi may see scope to push the benchmark interest rate below 1.00% as the non-standard measures have a limited impact in addressing the risks surrounding the region. As the EURUSD finally clears 1.3000, we should see the bearish formation pan out in May, and the pair looks poised to fall back towards the 23.6% Fibonacci retracement from the 2009 high to the 2010 low around 1.2630-50 as the fundamental outlook for the euro-area turns increasingly bleak. However, as the relative strength index approaches oversold territory, we may see a short-term correction later this week should the oscillator hold above 30, and we will look to sell rallies in the EURUSD as we anticipate to see a lower low in the exchange rate.

British Pound: BoE To Maintain Current Policy, Inflation Report On Horizon

The British Pound struggled to hold its ground ahead of the Bank of England interest rate decision, with the GBPUSD slipping to a fresh monthly low of 1.6073, but we should see the sterling maintain the upward trend from earlier this year as the central bank moves away from its easing cycle. The British Chambers of Commerce talked down the BoE’s asset purchase program as the nonstandard measure ‘has not led to a meaningful rise in lending to small and medium-sized firms,’ and we may see the central bank sound more hawkish this time around as the stickiness in underlying price growth raises the risk for inflation. However, as the BoE is widely expected to maintain its current policy in May, we may see the central bank refrain from releasing a statement, but the quarterly inflation report due out on May 16 may overshadow the meeting minutes for May 23 as we expect to see the central bank raise its fundamental assessment for the U.K. Nevertheless, we will be keeping a close eye on the vote count as board member Adam Posen scaled back his vote for more QE, and the committee may start to discuss a tentative exit strategy as BoE officials expect to see a more robust recovery in the second-half of 2012.

U.S. Dollar: Index Approaching 10,000, Fed Rhetoric In Focus

The greenback continued to track higher on Wednesday , with the Dow Jones-FXCM U.S. Dollar Index (Ticker: USDOLLAR ) advancing to a fresh weekly high of 9,998, and the reserve currency may appreciate further during the North American trade as the shift away from risk-taking behavior appears to be gathering pace. At the same time, the fresh batch of central bank rhetoric may prop up the dollar as Fed officials take note of the more robust recovery, and we may see the group of policy makers continue to soften their dovish tone for monetary policy as growth and inflation picks up. In turn, we should see the index continue to retrace the decline from earlier this year, and we will preserve our bullish outlook for the greenback as it continues to carve a series of higher lows in 2012.

--- Written by David Song, Currency Analyst

To contact David, e-mail dsong@dailyfx.com. Follow me on Twitter at @DavidJSong

To be added to David's e-mail distribution list, send an e-mail with subject line "Distribution List" to dsong@dailyfx.com.

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Original Article: http://www.dailyfx.com/forex/fundamental/daily_briefing/session_briefing/us_open/2012/05/09/Bearish_Euro_Formation_In_Play_Sterling_Outlook_Hinges_on_BoE.html