Asian sovereigns continue to drive the euro forward by Richard Driver of Caxton FX on 28-Feb-2012

The support that the euro has found in the past week or so is a difficult theme to explain, but market irrationality is no rare thing. Eurozone growth data was awful last week; German growth slowed down and the eurozone manufacturing and services sectors as a whole contracted in January. The market must have priced negative eurozone growth in to a large extent. There was some brighter forward-looking news from the German economy, which the market chose to focus on; a German business climate survey joined mid-February’s economic sentiment survey in beating expectations to the upside.

As has so reliably been the case in recent months, when confidence and investment in the euro from large sections of the market has waned as the debt crisis intensifies, Asian sovereigns' appetite for the single currency has remained solid. Asian central banks continue to diversify their reserves away from the US dollar in favor of the euro, as they seek to hedge their FX exposure.

The European Central Bank will be launching its second 3-year LTRO programme (cheap loan offering) on Wednesday. The effects of the first round of cheap loans in mid-December have been rightly celebrated as the reason for the stabilization we have seen in the eurozone. Bond yields in crucial countries like Italy and Spain are likely to be brought down again and it is likely to have a positive impact on sentiment towards the euro. Still, we do view the euro to be overbought and continue to anticipate a reversal of what has been a strong start to the year for the currency.

MPC minutes weigh on sterling but losses should be capped

Last week's MPC minutes saw sterling suffer badly. The minutes revealed that at the rate-setting committees meeting a fortnight earlier, two (out of nine) policymakers had voted for a £75bn increase in quantitative easing, as opposed to the £50bn that was actually decided. It is no great surprise that arch-dove Adam Posen was plumping for further stimulus, though the additional vote from David Miles was a turn-up. Nonetheless, sterling’s losses looked overdone and the likelihood remains that the committees other seven policymakers will be reluctant to step up the BoE’s QE programme once again.

Data last week confirmed that the UK economy contracted in Q4 2011 (by 0.2%). Nonetheless, hopes are cautiously building that positive growth will return in the UK this quarter and a technical recession will be avoided. Whether it will or not should become clearer over the next week, with February’s set of monthly growth updates due from the UK’s manufacturing, construction and services sectors. With little chance of a rate hike in recent months, sterling has not been too responsive to domestic data but with rating agency downgrades looming, improved growth data essential if the UK is to maintain its all-important AAA credit rating.

Sterling is trading down at &euor;1.18 today but the downside potential looks limited. The pound may begin to bounce soon. Against the US dollar, sterling continues to trade robustly. We have seen GBP / USD rejected twice at the $1.59 level during February, which could signal the end of its good run. In line with our bearish view of EUR / USD, we seeing the US dollar returning to favour soon. Another visit back down to $1.57 shouldn’t be too far down the road.

End of week forecast
GBP / EUR	1.19
GBP / USD	1.5750
EUR / USD	1.3250
GBP / AUD	1.47

Richard Driver is a Currency Market Analyst with Caxton FX and can be contacted via: www.caxtonfx.com

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