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Forex: Euro caution

Quite a day for the dollar yesterday and also sterling, with cable within touching distance of the 1.70 level. There was generalised dollar weakness at the start of the European session, with sterling helped by better services PMI data. There is also a growing perception that the status quo on the policy front cannot remain, with the Bank to set out its current thinking next week in its Inflation Report. But it could be the Financial Policy Committee that is where the action could be. This was set up so as to avoid bubbles and banking issues forming in the same way as the past and the buoyancy of the housing market could well see measures being taken, such as restraining the governments help to buy scheme or requiring banks to put more capital aside for mortgage lending. In theory, such a move would reduce the possibility of interest rate rises, because the pressure is taken off the Bank, but near-term it could be taken as sterling positive, because it would be seen as a sign from the authorities that the housing market is doing too well.

The single currently has weakened a little after yesterday’s gains. The focus remains on the ECB meeting tomorrow and the potential for further policy measures. The market is not clear that this will be seen tomorrow. A further cut in the main refinancing rate would have minimal effect (already at 0.25%) and could be problematic unless the deposit rate (currently zero) is moved into negative territory. The ECB has been debating other ways of undertaking quantitative easing, but the question is whether they have finalised their thinking on this controversial issue. With EURUSD close to 1.40, the preferred option could be for the ECB President to put in some well-placed words to soften the currency, but the impact of these could well prove transitory. 

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