Euro recovers losses on hopes of Greek deal

Tom Tong20/Φεβ/2012Currency Updates

The dollar rallied against most world currencies all the way into Thursday morning. The Euro was particularly punished by investors, as the dreadful European GDP data for the last quarter of 2011 trickled out. Renewed hopes for a second Greek bailout took hold early Thursday, and the common currency drifted higher along with risky assets all the way into Friday’s close. Though the dollar ended the week close to unchanged against most world currencies, this belies considerable volatility in intraday moves.


The Bank of England inflation report for February contained no dramatic surprises. Inflation is forecast to be somewhat below target at the end of the projection period, though not dramatically so (1.8% vs. a target of 2.0%). The MPC appears to be trying to hedge its bets as regards further increases in the gilt purchase targets. We now pencil in a further increase of 50 billion GBP once the current increase is finished. In support of our view, inflation fell sharply in January. Headline inflation dropped from 4.2% YoY to 3.6%. The more relevant core inflation measure dropped form 3.0% to 2.6%. As VAT hike effects fade out and utility bill reductions filters through, we see YoY inflation dropping below 1.5% by mid-year. Our negative view of the European economy carries over to the UK, and we expect Sterling to fall against the dollar as it rises against the euro.


The news out of the Eurozone could hardly be grimmer. GDP numbers for the last quarter of 2011 came out, and the picture for the different countries is anywhere from bad to catastrophic. The core is in trouble, the periphery is in deep recession, Portugal is in free fall, and the Greek economy is collapsing. Germany’s vaunted export machine sputtered, shrinking 0.7% saar. Italy and Spain are experiencing a full-fledged double dip recession, and they never even recovered from the previous one. Portugal (an obedient pupil which has dutifully implemented austerity policies) shrank a disturbing 5.3%, and Greece (which does not release official QoQ figures) is estimated to have dropped a mind boggling 18%, a number practically unheard of in peacetime economies. The failure of German-imposed austerity is complete. However, there are no signs that the German establishment is ready to acknowledge reality. In fact, its finance minister Schauble upped the ante in his campaign of political provocations by suggesting that upcoming Greek elections be suspended in order to facilitate German control over economic policy and the budget. We acknowledge to be somewhat surprised by Euro relative resiliency amidst this disaster, but believe that once the sizable short position is cleared out, the common currency will resume its drop against the US dollar.


Second-tier macroeconomic reports out last week were consistent with our view of an improving tone to the US economy and its labour market. In particular, we were encouraged by weekly jobless claims, which dropped below 350,000 for the first time since the first half of 2008.

Also, housing starts increased further last month. Fiscal policy has actually ceased to be a drag, as the retrenchment of state and local budgets has run its course, and agreement was reached on renewal of the payroll tax holiday and emergency jobless benefits. We continue to predict moderate employment growth driven by domestic demand for the rest of this year.


Written by Tom Tong

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