European Central Bank “would do whatever it takes” to preserve EUR

European Central Bank “would do whatever it takes” to preserve EUR

Good morning and welcome to today’s foreign exchange market commentary on Monday, the 30th of July.

Although Mario Draghi announced last week that the European Central Bank would do whatever it takes within its mandate to preserve the single currency, pushing the markets higher, no details were forthcoming. There were speculations that the Central Bank would start buying Spanish and Italian bonds to bring down unsustainable borrowing costs. Markets were right to a certain degree. However, anybody expecting a game-changing response may be in for some disappointment.

Buying Spanish and Italian bonds from the secondary markets isn’t the only option. The ECB can initiate another round of LTRO, cut interest rates further, agree to enhance the reserves of the EFSF and the ESM if the bailout funds are given a banking license or buy other assets.

Leveraging the ESM after granting it a banking license was reiterated by Austrian central bank governor Ewald Nowotny. However, since it violates the European treaty, such a measure may not be forthcoming.

That being said, more bond purchase by the ECB looks near-certain. Restoration of transmission of monetary policy is within the ECB’s mandate, a defence used before to buy sovereign bonds in 2010 and 2011. High sovereign yields due to factors not specific to a country or its creditworthiness, such as the potential break-up of the euro that may result in paybacks in peseta and lira, can call for the ECB’s intervention.

The moot question however is the actual size of bond-buying. Theoretically, it would require unlimited purchases, something likely to be vociferously opposed by Germany. The ECB must convince the markets that bonds held by it won’t rank senior to other creditors, forcing them to accept haircuts while the central bank stood to make profits. Other wise, the more bonds it purchase, the more investors would offload to exit.

While bond purchases can ease the pressure temporarily, the governments of Spain and Italy must undertake difficult reforms to fix long-term problems. Unfortunately both Mariano Rajoy of Spain and Mario Monti of Italy seem to be losing the momentum. Unless EU leaders stop fiscal profligacy, one can’t expect fireworks from the central bank.

CURRENCY RATES OVERVIEW

GBP/EURO – 1.2772
GBP/US$ – 1.5702
GBP/CHF – 1.5341
GBP/CAN$ – 1.5771
GBP/AUS$ – 1.5008
GBP/ZAR – 12.8415
GBP/JPY – 123.08
GBP/HKD – 12.1799
GBP/NZD – 1.9429
GBP/SEK – 10.8010

EUR: The single currency gained further traction on Friday after French President Francois Hollande and German Chancellor Angela Merkel made pledges to safeguard the future of the euro. Reports in French news paper La Monde that ECB President Mario Draghi will be meeting Bundesbank Head Jens Weidmann ahead of the Governing Council meeting on August 2 lent support to speculations that the central bank will start buying bonds of peripheral countries from the secondary markets. The GBP/EUR pair dropped to 1.2698 while the EUR/USD pair rose to 1.2390, though sterling regained its ground by late afternoon to close at 1.2772. The European Tier-1 economic data calendar is light today and the common currency is expected to take cue from the Italian govt. debt auction. The GBP/EUR pair opens at 1.2793 this morning.

USD: Cable traded higher against the greenback on Friday as risk sentiments remained well supported and the GBP/USD pair hit a five week high of 1.5768 while the EUR/USD marched ahead. The received some boost however, after Q2 GDP growth number came in at 1.5 percent, slightly better than the 1.4 percent forecasted by economists. The outcome of the Bank of England MPC meeting and the Federal Reserve FOMC meeting is expected to drive the GBP/USD pair this week. While the Bank of England is expected to keep the monetary policies unchanged, the Fed is unlikely to announce another round of assets purchase just yet. In the absence of tier-1 economic data from either side of the pond, the GBP/USD pair is expected to track the EUR/USD pair. The GBP/USD pair opens at 1.5710 this morning.

Have a great day!

 

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