Euro-zone structural vulnerabilities will continue to be key focus in the short-term and there will be persistent fears over the weaker peripheral economies. There will be speculation over a debt default, although the more likely outcome is that there will be some rescue package which will compromise medium-term confidence in the ECB and economic region. There will also be speculation of pressure on the central bank to delay any monetary tightening measures.
The Euro remained firmly on the defensive during the week with strong selling pressure on the currency. Selling intensified late in the week with lows below 1.37 against the dollar and lows below 122 against the yen.
Initial support from approval of the Greek budget deficit reduction plan was countered by a generally pessimistic tone from EU member Almunia who stated that the Greek position was very difficult. A decision by the Greek unions to back a strike also undermined confidence in the government’s ability to deliver spending cuts.
The very fragile sentiment was illustrated by the Euro falling sharply on rumours of a Spanish credit-rating downgrade and confidence is likely to remain fragile.
The ECB interest rate decision was in line with expectations as rates were left at 1.0%. The comments from Bank Chairman Trichet also suggested that rates would be left on for the next few months.
The comments on monetary policy tended to be overshadowed by budget and debt fears surrounding the weaker Euro-zone economies with a further focus on the Greek situation. Trichet commented that many member countries had large and sharply-rising fiscal imbalances which did little to bolster investor sentiment towards the region. As sovereign debt fears increased, the Euro was subjected to heavy selling pressure as sentiment deteriorated.
Yen:
The Japanese currency will still tend to gain some support when international risk aversion rises, especially if there is further speculation surrounding sovereign credit rating downgrades or defaults. There will also be a further lack of confidence in other major currencies which will provide net yen support. Underlying confidence in the Japanese economy will also remain generally weak and the yen is not well placed to make strong gains given its own vulnerabilities.
Trends in risk appetite have tended to dominate the yen for much of the week and the Japanese currency has gained strong support from a deterioration in global confidence. Equity markets were subjected to strong selling pressure while there was also a sharp retreat for commodity prices which curbed demand for carry trades.
The yen strengthened to highs beyond 89 against the dollar and also strengthened to near 122 against the Euro. US Treasury Secretary Geithner’s comments that the yuan could strengthen soon also boosted the Japanese currency.
There was evidence of importers selling the yen which helped the dollar rally back to the 89.60 region. There will also be pressure for the Bank of Japan to curb yen gains and there is the potential for some verbal intervention.
There was further speculation over a slowdown in the Chinese economy on continuing monetary tightening. In this environment, there were further reservations over a policy of aggressive yen selling which provided important protection to the currency, especially as commodity prices fell.
Domestically, the latest labour-market data recoded a sharp downturn in overtime earnings which will tend to undermine consumer spending trends and overall confidence in the economy will remain fragile which will curb yen support. |