The Euro will gain some support from expectations that the Euro-zone economy will start to recover. There are still important vulnerabilities which will limit the potential for Euro gains, especially if there are renewed fears over currency devaluations in the Baltic States. There will also be further unease over the banking sector and the possibility that the ECB will need to take more aggressive policy action to help stabilise conditions. Overall, the Euro is likely to find it difficult to make much headway from current levels.
The Euro secured a generally firmer tone on the main crosses during the week, but still found it difficult to make strong headway given lingering unease over the fundamental outlook. The Euro was unable to sustain gains above 1.41 against the dollar with firm buying support on dips to the 1.38 area.
The Euro-zone PMI manufacturing indices were firmer with the flash index rising to 42.4 from 40.7 the previous month. The services sector index edged slightly lower for the month, contrary to expectations of a measured increase, which will be a cause for some concern with fears that improvements are being driven by inventory adjustment.
The German IFO index rose to 85.9 for June from 84.2 the previous month, maintaining the improvement seen over the past few months. Companies were, however, still pessimistic over current conditions and IFO officials did not describe the improvement as defining a turning point for the economy
The comments from ECB officials were generally supportive of the Euro with council member Weber stating that the bank had used up the space to cut interest rates. Weber did, however, also stated that it was essential to avoid premature tightening. The OECD also stated that there was scope for ECB to cut interest rates further.
The ECB allocated EUR442bn in its debut one-year refinancing operation. This was higher than expected which increased speculation that there wee still very important stresses within the Euro-zone banking sector. There will also be speculation that a significant amount of funds were taken by banks outside the Euro area which could weaken the Euro.
Yen:
The evidence suggests that there will be further capital outflows from Japan in search of higher yields. These flows will tend to increase when confidence in the global economy improves and yen moves will continue to be correlated strongly with degrees of international risk appetite. Confidence is liable to falter over the next few weeks and this should be important in stemming aggressive yen selling pressure. There will be official unease over yen strength with the potential for verbal intervention on any substantial appreciation.
The dollar found solid support below 95 against the Japanese yen, although gains were very limited. The Japanese currency had a slightly weaker tone on the crosses with moves still generally measured.
The headline Japanese trade account remained in surplus for May, but the annual decline in exports was slightly higher than expected at 40.9% compared with 39.1% the previous month. There was still optimism that the industrial sector would continue to recover in the short-term as inventory adjustments eased.
Core consumer prices fell 1.1% in the year to May while there was a decline of 1.3% for Tokyo prices in the year to June which maintained underlying deflation fears within the economy.
The latest capital account data was again important with net outflows from Japan of US$3.5bn in the latest reporting week as domestic investors looked to increase their exposure to higher-yield assets. It was the seventh successive week of outflows which undermined yen sentiment with further investment fund launches. |