The currency blog

Europe took a major step towards greater fiscal integration overnight, as all EU members except the UK and Czech Republic agreed to measures to reduce budget deficits and allow greater oversight by the European commission. The pact should be in place by March with the ratification and implementation to follow shortly after.  Automatic fines of around 0.1% of GDP will be levied on countries who fail to reduce their deficits by the agreed proportions.  The fines smack of a token gesture given it will be one of the PIIGS that fail the tests and clearly they would not be expected to pay, and the fact that the Maastricht treaty imposed broadly similar rules which were blatantly broken by all member states is one of the reasons Europe finds itself in its current state of woe. As with recent EU meetings, the news will likely trigger a short lived Euro bounce before selling pressure resumes.

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The Federal Reserve minutes from the meeting earlier this month were released yesterday evening and after several months of treading water the Fed decided to change its wording on interest rates. The Fed now plans to keep rates at extraordinary low levels until the end of 2014, which is a year further than their previous stance and signals to the markets that the Fed will continue to provide a huge amount of monetary support even as the economy is recovering. The consensus was that the Fed would begin to withdraw support once they thought the economic recovery had gained traction but yesterday’s announcement has realigned the market view to expect low interest rates for a long time to come. The immediate reaction in the markets was positive with stock markets rising and a large move in the EUR/USD pair from 1.29 to over 1.31, which given the size of the move we can expect slight retrace back towards the 1.30 level during today.

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The Euro enjoyed its first strong day of 2012 yesterday with signs that some confidence could be returning to the single currency. One of the main topics of discussion at the moment is the ongoing Greek debt deal. Negotiations had taken a turn for the worse over the weekend after the authorities asked investors to accept new bonds yielding 3.5% rather than the previously agreed 4%. The Greek government had hoped to complete talks by Monday, but as yet, no agreement has been made. However, Greek finance minster Evangelos Venizelos said progress was being made and this was one of the main reasons for the Euro strength. He has now set a new date of 1^st February to conclude talks. Although these comments have improved the confidence level of a deal being agreed, until any deal is signed, expect the Euro to remain weak as the threat of a default is still alive.

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After several weeks on the sidelines, Sterling should be back on the mind of the market with two important announcements over the coming days. The first is UK GDP which is expected to show the return of negative growth, with the consensus estimate of 0.1%. The second, which will be directly influenced by the first, is the most recent MPC minutes. The market will be looking for any hint of further monetary easing over the next few months, the probability of which rises for every percentage point decline in the growth rate. It is looking likely that the UK will re-enter or may already be in a technical recession so further QE, which is Sterling negative, is highly likely at some point this year. In early trading this morning we are relatively unchanged.

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Against all the odds the single European currency has been resilient this week moving up towards the year to date highs of 1.3068, clawing back its losses and more.

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Like many of the other European governments, Spain’s new Partido Popular is adopting a hard-line stance towards the country’s economy. Since officially taking power a week before Christmas, the new government has already vowed to cut down on tax evasion and trim the public sector.

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