EURUSD continues to climb

(22.03.2011) The appetite for risk remained yesterday, and led to a further rise in international stock markets. The euro and pound sterling were the winners in the FX markets.

By Kjersti Haugland, Analyst at DNB Markets

euro coinIn the absence of new negative shocks from Japan, and rising hope that the situation at the nuclear power plants had stabilised somewhat, risk appetite held up yesterday. After having been closed on Monday due to holidays, the Nikkei index has risen by 4.0% on Tuesday. USDJPY remains quite stable around 81. The threat of new interventions is likely to have dampened the pressure on the yen. Also, expectations regarding repatriation flows may have subsided slightly due to somewhat lower pessimism.

The euro climbs further, and EURUSD is now traded around 1.42. All is set for a European hike in April, despite uncertainty connected to Japan and debt-ridden peripheral euro members. Yesterday featured hawkish statements from both the Italian and the Luxembourg central bank governors, who both said that ECB remains ready to react quickly to avoid rising inflation expectations. We agree that the ECB will be the first-mover in the hiking cycle, but we regard the market's expectations on ECB hikes in 2011 ass far too aggressive. Hence, we expect a lower EURUSD going forward.

In the meantime: preparations for the European Council meeting starting on Thursday continues. In the Eurogroup meeting on Friday two weeks ago Greece obtained easier borrowing conditions through a lower interest rate and a prolonged payment period. Ireland's solution has been held back by conflicts attached to the low Irish corporation tax, which for a long time has been viewed as an unfair market advantage by the other euro countries. The Irish has for long refused to touch its taxes, but on Monday they opened for negotiations. This could be the first step towards a more concrete "Europact", which so far is a very vague and general statement which states the need to harmonize budget and competition policy in Europe. It will be necessary for the Irish to make concessions to achieve softer conditions for their 85 billion euro loan.

The Socialist minority government of Portugal presented their tough austerity measure plan for the parliament yesterday, and said that they were ready to resign already this week if the opposition refuses to adopt it. With the measures implied by the plan, Portuguese GDP will, according to the government, decline by 0.9% in 2011. A vote is planned on Wednesday. Should the government be defeated on this matter, this means that an EU/IMF rescue fund solution will be even closer.

EURUSD was also supported by a weak outcome for the sole macro indicator of importance yesterday: US existing homes sale. The decline by 9.6% m/m was larger than even the most pessimistic estimate, and underlines that the US housing market remains depressed, despite positive news from other parts of the US economy lately.

The US Treasury will now liquidate its holdings of mortgage backed securities that were bought during the financial crisis. The MBS holding is worth USD 142 bn, and the announcement led to a temporary jump in US long government bond yields yesterday.

Pound sterling strengthened yesterday, and UK inflation for February is released today. Consensus according to Reuters is a rise from 4.0% y/y in January to 4.2% in February. After the dramatic events in Japan and Libya market expectations have moved from an expected hike in May to an expected hike in August. We continue to believe that BoE will deliver a hike already in May, and if today's February inflation surprises on the upside, market expectations may come back to May, and the pound may strengthen further.sc