Forex Analysis: Euro Hopes Fizzle On Dovish ECB- Reversal Underway

DailyFX   |  December 13 2012 9:05 EST

The Euro halted the advance from earlier this week as the European Central Bank (ECB) held a cautious tone for the region, and the single currency may trade heavy going into the end of the year as the deepening recession dampens the fundamental outlook for the euro-area.

Talking Points

• Euro: EU Agrees To EUR 49.1B Disbursement For Greece, ECB Remains Dovish
• British Pound: BoE Sees FLS Starting To Aid Economy, Hawkish Rhetoric On Tap
• U.S. Dollar: Retail Sales Misses Forecast, Jobless Claims Lowest Since 2008

Euro: EU Agrees To EUR 49.1B Disbursement For Greece, ECB Remains Dovish

The Euro slipped to 1.3039 even as the EU approved a EUR 49.1B bailout payment Greece, and the single currency may continue to give back the rebound from earlier this week as the European Central Bank (ECB) persistently highlights the ongoing risks surrounding the economy.

The ECB held a dovish tone in its monthly report as the deepening recession in Europe is expected to push inflation below the 2% target, and we anticipate the central bank to show a greater willingness to lower the benchmark interest rate further as ‘the Governing Council continues to see downside risks to the economic outlook for the euro area.’ At the same time, the central bank warned of the ‘differences in banks’ funding conditions and country-specific economic developments affecting the creditworthiness of borrowers’ amid the ongoing weakness in private sector credit, and we should see the central bank continue to embark on its easing cycle in 2013 as the governments operating under the fixed-exchange rate system become increasingly reliant on monetary support.

Although European policy makers agreed ‘to create a European bank supervision that’s supposed to start in 2014,’ the EU Summit in Brussels has done little to present a more immediate solution in addressing the debt crisis, and the reactionary approach held by the group may continue to drag on the exchange rate as the fundamental outlook for the region turns increasingly bleak.

As the EURUSD marks another failed attempt to test the 38.2% Fibonacci retracement from the 2009 high to the 2010 low around 1.3020, the triple-top in the exchange rate reinforces our bearish outlook for the pair, and we should see the euro-dollar work its way back towards the 23.6% Fib (1.2640-50) as the reversal pattern takes shape.

British Pound: BoE Sees FLS Starting To Aid Economy, Hawkish Rhetoric On Tap

The British Pound pared the decline to 1.6109 as the Bank of England (BoE) sees the Funding for Lending Scheme is ‘starting’ to show signs of working through the real economy, and we should see the central bank slowly move away from its easing cycle in an effort to address the stickiness in price growth.

As price growth in the U.K. is expected to expand at a faster pace in November, the BoE Minutes due out on December 19 may sound more hawkish this time around, and a growing number of central bank officials may start to discuss a tentative exit strategy in the following year as the U.K. emerges from the double-dip recession.

In turn, we are still looking for another run at the 23.6 % Fib from the 2009 low to high around 1.6200, but we may see a move back towards the 1.6300 figure before the end of the year as the shift in the policy outlook casts a bullish outlook for the British Pound.

U.S. Dollar: Retail Sales Misses Forecast, Jobless Claims Lowest Since 2008

The greenback pared the decline following the FOMC interest rate decision, with the Dow Jones-FXCM U.S. Dollar Index (Ticker: USDOLLAR) climbing to a high of 9,967, and the reserve currency may continue to recoup the losses from earlier this month.

Indeed, we saw a mixed batch of data coming out of the world’s largest economy as retail sales increased 0.3% in November amid forecasts for a 0.5% print, while the headline reading for producer prices slowed to 1.5% despite an uptick in the core reading. However, as initial jobless claims slips to the lowest level since April 2008, the ongoing improvement in the labor market may limit the Fed’s scope to expand its balance sheet further, and we may see the central bank conclude its easing cycle in the year ahead as policy makers take note of the more broad-based recovery.

In turn, the recent weakness in the U.S. dollar is likely to be short-lived, and the 2013 Federal Open Market Committee may soften their dovish tone for monetary policy as the recovery gradually gathers pace.

FX Upcoming

--- 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.

Will the EUR/USD Resume the Downward Trend From 2011? Join us in the Forum

Related Articles: Weekly Currency Trading Forecast