Euro To Face Increased Headwinds As ECB Maintains Current Policy, U.S. Dollar To Benefit As Market Sentiment Falters

Talking Points

Japanese Yen: Continues To Lose Ground As Risk Appetite Returns
British Pound: Construction Expands At Faster Pace in November
Euro: GDP Expands 0.4% in Third Quarter
U.S. Dollar: Pending Home Sales on Tap

The Euro pared the overnight advance as the European Central Bank talked down speculation for further easing, and the single-currency is likely to face increased headwinds over the near-term as the Governing Council refrains from addressing the risk for contagion. ECB President Trichet reiterated that monetary policy remain ‘appropriate’ during the press conference, and said inflation expectations remain firmly anchored as the central bank maintains its one and only mandate to ensure price stability. In addition, the central bank head noted that its exit strategy will be delayed as the governments operating under the fixed-exchange rate system struggle to manage their public finances, and went onto say that the uncertainties surrounding the economic outlook remains highly elevated as the financial system remains fragile.

As a result, Mr. Trichet said that the emergency measures will be an ‘ongoing’ program as the central bank aims to stem the risks for the region, but the lack of additional monetary easing could lead the bearish momentum behind the single-currency to gather pace throughout the remainder of the year as market participants speculate Spain and Portugal to share Ireland’s fate. Meanwhile, the preliminary GDP reading for the Euro-Zone showed economic activity expanded 0.4% in the third-quarter, which was largely in-line with expectations, while gross fixed capital formations held steady during the three-months through September amid projections for a 0.4% rise. A deeper look at the report showed household consumption increased 0.3% during the same period, which exceeded an initial forecast for a 0.2% rise in private spending, while government spending advanced 0.4% versus expectations for a 0.3% expansion. As the outlook for growth and inflation remains weak, the Governing Council could face increased pressures to take additional steps as the economic recovery in the Euro-Zone tapers off, and we expect the EUR/USD to completely retrace the advance from September as European policy makers struggle to restore investor confidence.

The British Pound fell back from a high of 1.5666 during the European trade to maintain the narrow range from earlier this week, and the GBP/USD may hold steady throughout the day as investors eagerly wait for the U.S. non-farm payrolls report due out tomorrow at 13:30 GMT. As the GBP/USD continues to trade below the 38.2% Fibonacci retracement from the 2009 low to high around 1.5700, we are likely to see the pair continue to trend sideways throughout the North American trade, but a shift in market sentiment could spark increased volatility in the exchange rate as risk trends continue to dictate price action in the currency market. Nevertheless, the economic docket showed construction in U.K. unexpectedly expanded at a faster pace in November, with the PMI reading advancing to 51.8 from 51.6 in the previous month, and the Bank of England may see scope to start normalizing monetary policy in the beginning of 2011 as the recovery gradually gathers pace. Given the stickiness in price growth, the BoE may turn increasingly hawkish as they expect inflation to hold above target throughout the following year, and interest rate expectations may gather pace over the coming months as growth and inflation accelerates.

U.S. dollar price action was mixed overnight, with the USD/JPY holding within the previous day’s range, and the major currencies may hold steady ahead of the non-farm payrolls release due out tomorrow as market participants expect the U.S. labor market to improve for the second consecutive month in November. Nevertheless, pending home sales in the world’s largest economy is forecasted to contract 1.0% in October after slipping 1.8% on the previous month, and the data could weigh on market sentiment as it reinforces a weakened outlook for future growth. As the economic docket remains fairly light for Thursday, we expect risk trends to dictate price action throughout the North American trade, and the rebound in risk appetite may gather pace as equity futures foreshadow a higher open for the U.S. market.

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