Stronger US GDP boosts the dollar

Lending to the eurozone’s private sector contracted further in July, which should encourage the European Central Bank (ECB) to maintain its loose monetary policy.

Private sector loans have shrunk 1.9% from the same month last year, while eurozone M3 money supply – a more general measure of cash in the economy – grew at an annual pace of 2.2% in July. This slowed from 2.4% in June but is above the consensus forecast of 2.1%.

With forward guidance tied to the inflation outlook, and with monetary dynamics subdued, the ECB will be inclined to keep rates as they are. Across the pond, the perceived inevitability of the US Federal Reserve’s unwinding of its quantitative easing (QE) programme as early as September has been thrown off balance in light of the intensifying escalation of military action in Syria. There is a good chance that capital flow will make its way to the safe-reserve haven of the US dollar; the Swiss franc and Japanese yen will also see increased inflows should the unthinkable take place. Financial markets have already flirted with risk-off mode over speculation that western military intervention is only days away.

However, the Fed may leave themselves open to a lack of credibility should they postpone any reduction of asset purchases. Furthermore, the revision of second-quarter GDP to 2.5% from 1.7%, against an expectation of a 2.2% increase, does imply that tapering will happen sooner rather than later. Yet circumstances can and do change.

The mere threat of an end to QE in the US has sparked a crisis in emerging markets. The risk of bond-buying trimming hurting economies from India to Turkey, by sparking an exodus of cash and higher borrowing costs, was a dominant theme at the recent annual meeting of central bankers and economists in Wyoming. A healthy US economy is the primary objective of Fed policy, however, and any indication of excessive domestic financial market volatility could bring about some dovish rhetoric from policymakers.

For now, the EUR/USD trade is caught in a 150-point range and hasn’t strayed too far above the $1.34 level. The pull-back below $1.33 should be viewed as bearish for the euro and could easily result in additional downside for the single currency, particularly in light of recent improved economic data from the US.

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