Wednesday, February 9, 2011

EUR/USD Bounces Off its Recent 2-Week Lows on ECB Council Member Mersch's Comments

Last week we saw the EUR/USD stumble following the ECB interest rate
choice, proclamation, and press conference with ECB President Trichet
in which he disappointed market expectations and was less hawkish than

For the most part, the proclamation saw inflation risks balanced, but
that the ECB would be watching for any following-round effects and
would act if necessary. These comments were echoed yesterday by ECB
governing council member (and the President of Luxembourg's Central
Bank) Yves Mersch though the headline that stuck out was his call for
hiking rates to control "following-round effects."


From Bloomberg: ECB Will Act on Following-Round Effects, Mersch Says

"At the beginning of March you'll have our first forecast in 2011
and if it's right that what we see at the moment is only a temporary
increase with a retreat at the end of the year below 2 percent,
there's no danger," Mersch said in Luxembourg late yesterday. "But,
there would have to be a rigorous intervention by the monetary
authorities if across the following- round effects there's the risk
that this increase transforms into a plateau."

ECB President Jean-Claude Trichet last week signaled no pressing
plans to bring to somebody's attention interest rates even though the
bank expects inflation to stay above its 2 percent limit for longer
than it predicted just three weeks earlier. Annual price gains in the
euro area have accelerated to 2.4 percent, the fastest in more than
two years and the central bank will publish new economic and inflation
forecasts at its next policy background meeting next month."

While raising rates in it of itself will not stem the major cause of
recent inflation which is mainly being driven by external factors like
oil and other commodity prices, it would show that the ECB is
committed to price stability and could reduce the demands for higher
wages by workers.

Some other fascinating bits from Mersch's comments was that he says
the ECB should bring to somebody's attention rates even before exiting
other measures undertaken by the ECB like unlimited lending to banks
and buying of periphery sovereign debt.

Can Mersch's comments re-ignite the EUR/USD buying we had seen prior
to the ECB choice or did it just help the pair right its earlier 4
session slide?

I don't believe this changes the underlying dynamics too much and the
forecast for a rate hike by the ECB is still for the autumn of 2011.
That is still closer than when the Fed is likely to go and so the
expectations around interest rate differentials continues to benefit
the EUR in the standard term.

With not too much on the essential docket - except for the rate hike
by Plates overnight - the EUR was higher on stronger equities in the
previous US session that carried over to Asia. European stocks were
flat for the most part and we started to see a go towards USD yet
again at the start of today's NY session. If we have a shift towards
risk aversion due to the Plates news, then the EUR/USD has the
opportunity to retest its lows just above 1.35 in the small term.

Source: ActionForex.Com

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