Euro Rally At Risk, Sterling To Falter On More QE

DailyFX   |  February 8 2012 9:35 EST

Market sentiment continued to pick up on Wednesday as Greece edged closer in securing its second bailout package, but the rise in risk appetite could be short-lived as we expect the European Central Bank to strike a cautious outlook for the region.

Talking Points

• Euro: Germany Prepares To Vote On Bailout, ECB To Preserve Dovish Tone
• British Pound: BoE To Expand QE, 38.2% Fib To Serve As Support

Euro: Germany Prepares To Vote On Bailout, ECB To Preserve Dovish Tone

The Euro climbed to an overnight high of 1.3287 as European policy makers prepare to release the EUR 130B rescue package for Greece, and the single currency may appreciate further during the North American trade as the development fuels risk-taking behavior. Indeed, Germany said it may vote on the bailout package as soon as next week according to a spokesman for the Christian Democratic Union, while the deputy CEO of the European Financial Stability Facility said the fund will probably play a role in the Greek PSI as the European Central Bank refuses to take a haircut on its Greek debt holdings.

As talks on the debt-swap deal are expected to resume in Paris tomorrow, positive developments coming out of the meeting is likely to increase the appeal of the single currency, but the European Central Bank interest rate decision could pave the way for a short-term reversal in the EUR/USD as we expect President Mario Draghi to maintain a dovish tone for monetary policy. As the euro-area slips back into recession, the ECB may talk up speculation for additional monetary support, and the Governing Council may see scope to push the benchmark interest rate below 1.00% as subdued growth dampens the outlook for inflation. At the same time, Mr. Draghi may encourage commercial banks to take advantage of the second three-year loan facility on tap for the end of the month, and we may see the central bank carry its easing cycle into the second-half of the year as the fundamental outlook for the region remains bleak. As the EUR/USD struggles to push above the 100-Day SMA at 1.3340, we should see the exchange rate consolidate ahead of the ECB rate decision, but the euro-dollar could face a sharp selloff if the central bank surprises the market with a 25bp rate cut.

British Pound: BoE To Expand QE, 38.2% Fib To Serve As Support

The British Pound pared the rally to 1.5928 as market participants expect the Bank of England to boost the Asset Purchase Facility beyond the GBP 275B target, and the sterling may face additional headwinds on Thursday should the central bank keep the door open to expand its balance sheet further. According to a Bloomberg News survey, 49 of the 50 economists polled see the BoE increasing the AFP by at least GBP 50B in order to shore up the ailing economy, but the central bank may see scope to expand monetary policy further over the coming months as the Monetary Policy Committee continues to see a risk of undershooting the 2% target for inflation. In turn, the GBP/USD may have put in a near-term top following the failed run at the 200-Day SMA (1.5944), and should see the exchange rate fall back towards the 38.2% Fibonacci retracement from the 2009 low to high around 1.5730-50 to test for support.

More to Follow...

--- Written by David Song, Currency Analyst

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

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