Euro crushed further on ESM rumours

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The market once again gave the euro a beating yesterday and sent it to fresh 9 month lows versus sterling and close to the 1.30 level versus the US dollar. The decay only really started at around 15.30 when reports came from within the German ruling coalition that Angela Merkel had ruled out an increase in the upper limit of the European Stability Mechanism. You combine that with moves by Fitch to cut Bulgaria, Czech Republic, Latvia and Lithuania’s credit outlook on fears that the Eurozone crisis will hammer them and the velocity of the downward move was set to “full steam ahead”.

The move, however wasn’t echoed in equities or in bond spreads yesterday afternoon, which suggests that something may be amiss. A fall in EURUSD of over 1.5% would normally see a similar if not larger fall in the value of European indices and you’d also expect Italian and Spanish debt yields to smear higher. None of this happened. Whether this was a result of the poor liquidity that is starting to become a factor is unknown but it seems an obvious reason. The move also blew through a fair few “technical levels” that would see automatic, computer based trading orders executed that would have exacerbated the move.

Prior to the announcement the day had been fairly peaceful. UK inflation exceeded the Bank of England’s target for the 24th month in a row although we are starting to see price levels start to moderate as food and transport costs slipped. We broadly agree with the Bank of England that we should see a good fall in inflation through 2012 as components such as the VAT increase fall out of the basket. The main inflation fear through 2012 is that on-going tensions in the Middle-East between Israel and Iran over the latter’s nuclear policy leads to some form of pre-emptive strike by the former and oil goes bananas as a result. Rumours in trade over the past couple of days have been that Iran is looking to close the Straight of Homuz, a valuable oil shipment channel, for some naval exercises and crude oil was around $3 higher on the day as a result.

The bond market auctions yesterday were well received and made few headlines but we do have an Italian auction today of 5yr debt that could throw a spanner in the works for those looking for a stronger euro. Mario Monti published details of his emergency budget yesterday and it goes to a parliamentary debate today. The IMF is also due in Italy next week and I doubt it’s purely to pick up some panettone for Christmas.

The Federal Reserve decision was a bit of a non-event yesterday although equity markets had been looking for some form of easing it seems as they took a leg lower at the announcement that policy was unchanged. This is strange as it seemed obvious that the committee would not move before the situation in Europe is clearer. The Fed said that the US economy, while improving, is still weak. Unemployment remains high, and it remains vulnerable to the European debt crisis, which could push the continent into a recession and slow US growth. You could substitute any central bank/country into that sentence and it work at the moment however.

Data today comes from UK unemployment with the figures expected to slip further with the jobless claims number for November set to increase from 5.3k in October to 13.7k.

Indicative Rates Sell Buy
GBPEUR 1.1894 1.1921
GBPUSD 1.5500 1.5525
EURUSD 1.3016 1.3039
GBPJPY 120.85 121.13
GBPAUD 1.5486 1.5514
GBPNZD 2.0521 2.0549
GBPCAD 1.6047 1.6076
NZDUSD 0.7548 0.7576
GBPZAR 12.89 12.94
USDZAR 8.3073 8.3401
GBPPLN 5.4319 5.4615
EURJPY 101.45 101.73

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