Market euphoria may fade as Berlin unlikely to write a blank cheque

Market euphoria may fade as Berlin unlikely to write a blank cheque

Good morning and welcome to today’s foreign exchange market commentary on Wednesday, the 4th of July.

Success at last week’s EU summit ensured positive measures to contain the immediate market panic. However, there are far bigger worries that need to be addressed. Spain and Italy’s GDPs are shrinking and there’s no proposal to reverse the trend.

That being said, the summit’s achievements were no mean feat. The agreement that Europe’s banks should be able to access the bailout funds for recapitalization purposes directly at a later date circumventing national governments is no small success as it will break the doom-link between troubled banks and troubled sovereigns. That will bring down Spanish and Italian borrowing costs and would help both the countries avoid a full bailout. And Ireland, which is in a bailout program, could exit and tap the capital markets again.

However, as the fine prints of the agreements emerge in future, the market euphoria may very well fade since Berlin is unlikely to write a blank cheque. Take for example the €100 billion recapitalization plan by Madrid. Dublin has already sunk €64 billion in its banks. It’s unlikely that the full amounts will be reimbursed by the euro zone since the stakes in the lenders don’t add up to that much.

Or look at the bail out funds meant for stabilizing markets. With limited resources, they are unlikely to keep Spanish and Italian borrowing costs down in the long run. Countries seeking to access the funds will also have to agree to market reforms, which is likely to be seen an encroachment over sovereignty. This also probably explains why Greece and Spain are not rushing in to sign up.
Europe is still far away from a political union. It’s better to keep debt-sharing and loss of sovereignty at minimum till a larger consensus evolves. Last week’s summit has at least taken baby steps in the right direction.

CURRENCY RATES OVERVIEW

GBP/EURO – 1.2442
GBP/US$ – 1.5668
GBP/CHF – 1.4952
GBP/CAN$ – 1.5876
GBP/AUS$ – 1.5236
GBP/ZAR – 12.6625
GBP/JPY – 124.92
GBP/HKD – 12.1451
GBP/NZD – 1.9482
GBP/SEK – 10.8817

EUR: The single currency remained range-bound against the USD and the GBP on Tuesday as traders were reluctant to put any large bet ahead of the European Central Bank’s interest rate decision on Thursday. There’s a wide anticipation that ECB Governor Mario Draghi will cut rates by 0.25 percent to 0.75 percent, but the market is being cautious in the face of uncertainties surrounding the EU policymaking. The US is closed in observance of Independence Day celebrations though we have European services PMI and retail sales data to look forward to. Also Italian Prime Minister Mario Monti and German Chancellor Angela Merkel are scheduled to meet today in Rome this afternoon and the single currency may take cue from the headlines of the meeting. GBP/EUR opens at 1.2442 this morning.

USD: The cable remained mostly range-bound against the greenback yesterday despite UK construction PMI number coming in softer than anticipated. Though construction contributes only eight percent to British GDP, Tuesday’s report showed construction activity dropped the fastest in 2-1/2 years in June. As the US markets remain closed today on account of Independence Day holiday, action in the FX market is expected to remain muted today ahead of Thursday’s interest rate decision by the Bank of England. UK services PMI data is due today and any weakness would strengthen the chatter for further QE tomorrow. GBP/USD opens at 1.5676 today morning.
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Have a great day!

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