The ECB and the EUR

The EUR was hit yesterday by negative headlines from Fitch and from rumours about credit ratings.  The former appeared to be taken out of perspective while the latter were also dismissed – for now.  

The EUR, however, failed to recover much lost ground underpinning the fact that despite record short positions its remains a very vulnerable currency.  The ECB policy meeting is clearly the main event for today but the meeting cannot claim full responsibility for yesterday’s soft tone of EUR/USD. 

Market surveys are suggesting that only 10-15% of survey participants are expecting the ECB to ease policy today.  We expect that Draghi will want to see how the dust settles following the previous two months’ rate cuts.  He will also be wary of cutting rates below 1.0% since retaining the interest rate corridor whilst cutting 25bp would imply a zero deposit rate which may create distortions. 

Also, with another LTRO approaching in February the Bank are still actively involved in dousing the flames of the Eurozone crisis.  

Today’s Spanish bond auction and tomorrow’s Italian supply provide good reasons for the EUR’s nervousness.  Spain did see decent demand at its debt auctions at the end of last year but since then the government has had to admit that it budget deficit/GDP ratio was far higher than intended in 2011. 

The price at which investors are willing to fund the budget deficits of Spanish and Italy will provide a good gauge of the relative success/failure of EMU politicians in their efforts to tackle the crisis and restore confidence in the system.  Given that the crisis rages on, even mediocre auction results are likely to bring some relief to the EUR. 

Oversold momentum is also likely to contribute to some stability in EUR/USD should the Spanish auction results today provide some relief, but we remain of the view that rallies in EUR/USD offer selling opportunities ahead of a move towards EUR/USD1.2500 on a 3 mth view.  The EUR/USD1.2700 area is providing support this morning, ahead of the USD1.2665 area.  The Tenkan line at EUR/USD1.2870 should offer decent resistance.  The week’s high at EUR/USD1.2820 may offer support ahead of that.


source: Rabobank