EUR Supported By Plummeting Pound

Fleet-footed Mario Draghi deserves the plaudits for the aggressive actions undertaken last week. The European Central Bank’s (ECB) surprise rate cut has led to some serious volume spikes in forex trading — volume and volatility provides opportunity, something that has been amiss for far too long with this asset class. More importantly, the ECB chief managed to surprise capital markets with lower interest rates and announced a plan that looks a lot like quantitative easing, or QE. Both necessary moves executed with a much more aggressive tone. Nonetheless, there is much to do and the ECB is still falling short. Many believe that eurozone policymakers aren’t doing enough and they may even be compounding that error by advertising their own impotence.

Flaccid Fiscal Policy is Ineffective

The fear that European fiscal policy cannot lead to inflation would suggest that there is a massive need for further monetary stimulus. Currently, the ECB’s target for inflation is close to, but below its desired +2%. Actual inflation is now +0.3% and worse, forecasts show inflation running well below the bank’s target +2% for the next two years — 2016 is +1.4%. So, did last week’s announced new measures added to the minor changes Draghi and company announced in June go far enough? The actual rate cuts are relatively inconsequential — benchmark lending from +0.15% to +0.05%, while deposits held at the central bank were cut from its negative -0.1% to -0.2%. Many feel that the direct effects will be insignificant. It’s a start, but much more is required to be done, hence the introduction of both the asset-backed securities and long-term refinancing operation programs.

Euro Data Offers Mixed Fortunes

This morning’s Euro data is providing some mixed fortunes for the 18-member single currency. The massive drop in the research group Sentix’s eurozone investor sentiment index (-9.8 versus 3.2) is certainly a wake-up call for EUR traders despite Draghi’s efforts last week. Germany is the backbone of Europe, and this morning’s monthly record trade surplus stole the headlines (+22.2B versus +17.3B), possibly pointing to a strong third quarter. However, caution is in the details, investors should remain wary of the import drop; it’s bad news. If you add this to the European Union’s and U.S.’s sanctions imposed on Russia, which will only add to Europe’s growth woes, the suggested third-quarter boon may be way off the mark. Despite it all, the intense bearish speculation will fade most EUR (€1.2944) rallies. The single unit is currently underpinned by more EUR/GBP short covering.

Not all things are necessarily bad for the EUR. Nevertheless, its liquidity will help to support Asian equity market valuations, and provide that region with cheap finance to support its buoyant economies. Europe’s political and economic woes will eventually send more trade deals to Asia. Even the go-to and overcrowded carry trade will be capable of kicking in from here. The ECB’s stated intentions of cheaper financing will continue to feed these trades — borrowing the cheap EUR to invest in higher-yielding assets like the AUD regardless of the Reserve Bank of Australia’s efforts to talk it down (AUD$0.9347). Europe’s virtually free-money policies have failed to raise and steady the eurozone’s consumer lending, or to stimulate investment spending, leading to investors to seek returns elsewhere. Despite the intense bearish speculation the comfort trade is to fade a EUR rally; however as €1.2920 breaks with conviction, then a percentage of the market will be forced to have a rethink.

Cable Plummets on Scottish Poll

Among the dollar majors this morning, the biggest fluctuation has been seen in sterling, which has fallen just under two-cents from last Friday’s close to £1.6112, a 10-month low. Investors are unnerved by the uncertainty related to the possibility of Scotland’s referendum for independence after a YouGov survey revealed that supporters of independence are in the lead for the first time by a 51% to 49% margin. The Scottish referendum vote is scheduled for September 18. The market is becoming more fearful not just of an outright defeat for the U.K., but of the so-called “Québécois scenario” (what occurred in Canada in 1995). It’s where a narrow rejection of independence leaves open a risk of future referendums. This will obviously have a massive impact on U.K. banking, gilts (+2.49%), and direct investment in Scotland from everywhere and on the pound itself. When Quebec wanted independence, Canada as a nation suffered. Even a pro-independence vote will unnerve capital markets until all the details are clearly ironed out.

Despite the YouGov poll grabbing all the headlines, another poll commissioned by the independence party has the no vote ahead by +4%. For GBP, uncertainty will be rife until the vote, with volatility to remain high allowing further stops capable of being hit before any reversal. Many are looking at EUR/GBP (€0.8035) as the best vehicle to express their bullish bets on the pound. If no is the verdict, then investors will be influenced by the divergence between the ECB’s and the Bank of England’s monetary policies.

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This article is for general information purposes only. It is not investment advice or a solution to buy or sell securities. Opinions are the authors; not necessarily that of OANDA Corporation or any of its affiliates, subsidiaries, officers or directors. Leveraged trading is high risk and not suitable for all. You could lose all of your deposited funds.

Dean Popplewell

Dean Popplewell

Vice-President of Market Analysis at MarketPulse
Dean Popplewell has nearly two decades of experience trading currencies and fixed income instruments. He has a deep understanding of market fundamentals and the impact of global events on capital markets. He is respected among professional traders for his skilled analysis and career history as global head of trading for firms such as Scotia Capital and BMO Nesbitt Burns. Since joining OANDA in 2006, Dean has played an instrumental role in driving awareness of the forex market as an emerging asset class for retail investors, as well as providing expert counsel to a number of internal teams on how to best serve clients and industry stakeholders.
Dean Popplewell