FX - Euro and Pound May Fall as German ZEW, UK CPI Weigh on Rates Outlook

The Euro and the British Pound may decline as Germany’s ZEW survey of investor confidence and UK consumer price index figures underscore the lackluster interest rate outlook for European central banks.

Key Overnight Developments

• New Zealand House Price, Sales Data Weigh on Rate Hike Outlook
• Australia to Hold Interest Rates as RBA Gauges EU Crisis Fallout
• Bank of Japan Holds Rates at 0.10%, Introduces New Lending Facility

Critical Levels



The Euro tracked slightly lower against the US Dollar in Asian hours, down as 0.1 percent as markets retraced following the run-up to the 1.23 figure in New York trade. The British Pound was little changed on the session. We have opted to exit our short EURUSD position.

Asia Session Highlights



New Zealand House Sales fell 17.2 percent in the year through May – the largest drop in 15 months – according to a report from the Real Estate Institute of New Zealand (REINZ). House Prices fell 1.4 percent from April, making the second consecutive decline and the largest one in four months. The median time to sell a property rose to 43 days, the highest since February. The figures suggest the central bank will likely take a measured approach to further interest rate hikes, reinforcing the cautious wording accompanying last week’s policy announcement. Indeed, a Credit Suisse gauge of priced-in rate hike expectations showed traders now see the likelihood of another 25bps increase in July at 52 percent, down from 76 percent just yesterday.

Minutes from the Reserve Bank of Australia’s June policy meeting bolstered expectations that further interest rate hikes are likely off the table for the time being. Policymakers said borrowing costs are now around “average levels” – their stated objective for much of the tightening cycle – and added that the situation in Europe has “deteriorated significantly”, arguing that previous rate hikes provide “flexibility” to wait for a clearer reading on the impact of EU-linked financial market turmoil on the global recovery.

The Bank of Japan voted unanimously to keep interest rates at 0.10 percent as expected but announced a new lending program totaling 3 trillion yen to begin by the end of August in a bid to beat deflation, which it again indentified as a “critical challenge”. Policymakers also restated their intention to maintain an “extremely accommodative” environment.

Euro Session: What to Expect



UK Consumer Price Index figures headline the economic calendar, with expectations calling for the core annual inflation rate to decline to 2.9 percent in May from 3.1 percent in the previous month, the first slowdown in three months. The outcome may help to reinforce the Bank of England’s argument that the recent upswing in prices owes to temporary factors, with current policy sufficient to bring inflation back toward the 2 percent target level over the medium term. Easing inflationary pressure would also give the central bank the flexibility to retain stimulus for a longer period than otherwise as the government prepares to announce an Emergency Budget next week. As we noted in our British Pound weekly forecast, whatever mix of new taxes and spending cuts is finally revealed, one thing that seems certain is that a period of austerity lies ahead as policymakers tackle the UK’s soaring budget deficit. The growth rate of government spending has regularly outpaced that of private consumption since the first quarter of 2008, so any retrenchment on the fiscal side is likely to bring a slowdown in GDP expansion. This hints the BOE will need to press forward with an accommodative posture longer than most monetary authorities (with the notable exception of the ECB as explained below), an outcome that surely bodes ill for the UK currency.

Turning to the continent, Germany’s ZEW Survey of investor confidence is set to show that the outlook for economic growth in the Euro Zone’s largest economy soured for the second consecutive month in June. The outcome seems hardly surprising considering the likely implications of the EU debt crisis. Indeed, financing gaping deficits will drive up borrowing costs and weigh on output as businesses find it more expensive to expand capacity while consumers shy away from big-ticket purchases typically made on credit. Naturally, this is also likely to keep the ECB in dovish mode longer than most of its major counterparts, weighing on the EUR exchange rate.

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