Downward revision for the euro in the short term. As for the projected dynamics, the underlying assumption is that the Greek crisis will not get out of hand. The FOMC meeting will also be a factor. The Yen lacks own stories, but will react to the FOMC and to US data. Sterling may drop slightly more if the BoE minutes reveal a “less neutral” debate than usual……
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EUR – We have revised downwards our 1m and 3m projections for the EUR/USD exchange rate, from 1.50 to 1.47, and from 1.43 to 1.40 respectively. The revision is justified by the latest developments on the fronts of Greece and the ECB. The Greek crisis has become increasingly complex in the past few days, triggering a sharp correction, from 1.44 to 1.40. As regards the ECB, the exchange rate’s downside reaction to the outcome of last week’s meeting suggests that the market is fully pricing in a rate hike in 3Q 2011 (expected in July), followed by another in 4Q. Also, barring data/events generating expectations for a further interest rate rise before the end of the year, the upside potential associated with the rate hike scenario priced in by the market is therefore rather compressed.
Also, we estimate an exchange rate level compatible with two ECB rate hikes in the aforementioned period of time at around EUR/USD 1.43, therefore approximately in the 1.40- 1.45 range.
We confirm our expectations for a potential recovery from current levels on a 1m horizon, while specifying that the underlying assumption is that the Greek crisis will not get out of hand, i.e. the country does not incur a default, and a rescue plan is successfully launched in the meantime.
On Sunday, the EUR 12Bn instalment of the loan agreed last year should be issued. Next week’s other important dates with regards to the Greek crisis are Monday, when the Eurogroup will meet, and Tuesday, when the Greek government could face a confidence vote and the Ecofin is due to meet. In the event of setbacks, a foray below 1.4000 cannot be ruled out: first important supports at 1.3956-1.3862-1.3775-1.3724.
Lastly, another event might have some impact on the exchange rate: the FOMC meeting. Expectations are that the Fed will hint at a wait-and-see phase, and push back the start of the rate hike process to 2Q 2012, later than previously expected. This could play to the advantage of the euro, but any potential contribution should prove to be modest, as the market is not pricing in hikes in 2011, and places expectations for the first rise between January and March 2012. A second hike by the end of June is no longer entirely likely according do market prices.
GBP – Data on the performance of the UK economy were rather negative this week. Sterling suffered as a result, and dropped from GBP/USD 1.64 to 1.60 against the dollar. GBP/USD 1.60 is a tough level to breach. Next week will see the release of the minutes of the latest Bank of England meeting. We expect the divide within the Board to have remained unchanged compared to the previous month, with three members in favour of an immediate rate hike, and the other six calling for unchanged rates. Barring revelations that another member voted in favour of a hike (unlikely in our view), the most important aspect will be the terms of the internal debate. The BoE, while stressing the still mixed nature of data, may wish to highlight the signals of weakness given off by those release in the days leading up to the meeting, first among them MAY PMI data. In this case, sterling may start to ease back somewhat.
What’s more, if the two CBI surveys due out on Tuesday and Thursday, the first referred to June, lay bare a deterioration, the pound would have room to start dropping below GBP/USD 1.60. There is no “guarantee” of the potential drop against the dollar transferring also to the euro, as the EUR/USD ratio should confirm its dominant role.
JPY – The yen continues to lack own stories, and should react to events in the United States. An outcome of the FOMC meeting along the lines described above could weaken the dollar, possibly threatening a subsequent downside breach of USD/JPY 80.00. Uncertainty over global growth on the one hand, and the Greek crisis on the other, could help keep the yen strong. However, if USA data surprise on the upside, the exchange rate should react readily, climbing back to at least USD/JPY 81, therefore reflecting a weakening – albeit still modest – of the yen.
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