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Forex snapshot

Not all central bank meetings are created equal, with many going down the soporific route for the most part. It must be said that recent European Central Bank press conferences have garnered a great deal of attention, and today is no different.

Mario Draghi
Source: Bloomberg

German factory orders disappointed last month, showing a decline of 3.2% but bounced back in August rising 1.6% against a forecasted 0.5% rise; the July number was also revised slightly to a decline of 2.7%. Still, cracks are starting to show in the powerhouse of the European economy, and it’s this weakness that has bolstered both the case and speculation for the ECB to embark on quantitative easing.

While Mario Draghi can take the credit for removing some of the scepticism surrounding the single currency with his off-script ‘whatever it takes’ remark, it would seem that most of the member states have not been able to take advantage of the reprieve.

More than once, Mr Draghi has signalled that in order for additional liquidity to take effect, governments in the three largest eurozone economies, France, Italy and Germany will need to reform their economies. This should include spending flexibility and the removal of barriers to growth and job creation.

EUR/USD under significant pressure

The ECB is unlikely to move further before its last gambit - a new round of cheap long-term money for banks, which it hopes will be loaned into the real economy, has even taken effect.

The consensus is that the bid rate will remain at 0.15%. Inflation stands at less than a fifth of the ECB’s target of 2% so some are speculating another rate cut may be announced today.

As usual, Mario Draghi’s language will be closely monitored during the press conference and nothing short of some signal that extraordinary measures are imminent will appease the markets. Given the strong opposition from the German finance minister Wolfgang Schaeuble to the mere notion of QE – it may prove difficult to push this through.

With many pricing in an aggressive policy move from Mr Draghi today, the euro has been under significant pressure but appears to have found a bid around the $1.31 level. Much of the bounce in the last trading session is short covering ahead of both the rate announcement.

For now, gains in the euro have been capped by the $1.3150-60 range so a convincing move through this metric argues for a return to the $1.32-$1.3220 zone. The daily relative strength index is oversold, so this short squeeze certainly cannot be ruled out. This week’s lows of $1.3110 will need to be watched too. Any surprises from the ECB could see the euro break lower towards $1.3060.

GBP/USD could return to $1.65

The Bank of England governor seems to have convinced markets that the UK economy is not yet in a situation that could tolerate a rate hike. The Monetary Policy Committee may have moved away from unanimity recently, with two members voting for a 0.25% hike, but since then we’ve witnessed lower inflation levels and a distinct lack of wage growth. The British economy grew by 0.8% in the second quarter of this year, matching its output from the previous first three months. Imbalances in the economy are also evident with construction and services remaining steady, while manufacturing output has not been keeping pace.

The slowdown in Europe, the UK’s largest trading partner, is likely also delaying any tightening.

The moves in GBP/USD indicate that markets are no longer expecting the BOE to attempt to steal a march on other western central banks. With the Scottish referendum later this month, the BOE will be keen not to add to the current volatility levels. Upsetting the apple cart ahead of the British general elections in May is also something the bank will wish to avoid.

Recent surveys of the housing market have offered mixed signals about the strength and durability of the upturn. Given that this is the sector that presents the most risk to a burgeoning economy, it seems that Mark Carney is happy to allow the stringent mortgage approval practice to remove some of the heat in the area.

The pound has shed 4.3% against the dollar since mid-July, hitting a seven-month low yesterday at $1.6440. Like EUR/USD, the daily RSI is looking oversold and given that price action is resting at the 38.2% Fibonacci retracement of the move down from the November 2007 highs to the lows of February 2009, we may see a bounce over the coming days.

It’s difficult to take a position against the greenback at the moment, which shows little sign of fatigue, but with some positive RSI divergence on the short-term charts we could expect to see the pound pop back towards $1.65.

Below the $1.6440 level lies $1.64 then $1.6385.

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