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European markets set for another positive week

It's seven weeks and counting as European markets look set to extend their winning streak further away from their March lows. The FTSE 100 in particular has outperformed, helped by further increases in the oil price to their highest levels since 2014, as well as a pound that has fallen to within a few pips of its lows this year against the US dollar, after the Bank of England kept interest rates on hold.

In Italy, markets sagged sharply after it became apparent that the leaders of the populist Five Star movement and the Lega party were close to putting together a possible coalition partnership, which could in turn prompt a confrontation with EU officials over reform measures and tax rises, as well as a spending splurge in defiance of budget rules.

The two parties remain unlikely bedfellows when it comes to political alignment, which means that any agreement is unlikely to be harmonious but nonetheless, at a time when Italy needs to reform its economy, as well as fix its banks, it is a distraction that it can ill afford.

Even US markets appear to have recovered some of their recent lost mojo, having struggled in the past few weeks they look on course to post their strongest weekly gains since early March, as declining concerns about a sharp rise in inflation saw long term yields soften, and the US dollar slip back a little.

The pound had a pretty disappointing day yesterday, coming under pressure over a combination of multiple downgrades in the UK’s growth as well as inflation outlook, after the Bank of England kept rates on hold. There was a distinctly more dovish flavour to the narrative even though the voting arithmetic remained split 7-2 with both Ian McCafferty and Michael Saunders maintaining their calls for an increase in rates.

While governor Carney attempted to put a brave face on the downgrades by suggesting that rate hikes still remain on the table for this year, and that the bank expected the slow down seen in Q1 GDP to be temporary, markets didn’t appear to be buying the narrative on this occasion, sending sterling down towards its lowest levels this year against the US dollar.

This shouldn’t really be a surprise when on the one hand you chide markets for underestimating the likelihood that rates could rise faster than expected earlier in the year, only to row back on that within the space of three months. Sadly, this isn’t the first time this has happened and as such the Bank of England may well struggle to convince markets it is serious when it wants to communicate a message in the future.

The downgrade to the inflation forecast was particularly surprising given recent rises in oil prices, as a well as a number of changes to taxation levels and pension contributions that came into effect in April, which are likely to pinch consumer incomes further.

It was also somewhat of a surprise to see Chinese CPI fall back to 1.8% in April, a sharp fall from the 2.1% seen in March, which coming as it has on the back of similarly weak EU CPI numbers from last week, and a lacklustre US CPI number it would appear that whatever inflation there is at the moment isn’t showing up in the headline numbers. It is this weakness that appears to be encouraging equity market bullishness this week.

Whether that continues to be the case remains to be seen but the divergence being seen between headline CPI numbers and commodity prices is a bit of a concern.

Forex snapshot

EUR/USD – yesterday’s reaction off the lows this week could prompt a bit of a pullback in the coming days. Having found support at 1.1820 we could retest the 200-day MA above the 1.2000 area. The next key support area remains down near the 1.1780 level, as well as the December lows at 1.1710.

GBP/USD – slipped back towards the lows so far this year near 1.3460 before rebounding. The last few days has seen the pound struggle to overcome the 1.3620 area. We need to move back above the 1.3630 area to stabilise. A failure to do so invites further losses towards the 1.3300 area in the medium term.

EUR/GBP – yesterday’s rebound has seen us revisit the area close to last week’s highs with resistance also at the 200-day MA at 0.8880. We still seem to be in the same range we’ve been over the last few weeks, with support at 0.8740 and the 0.8680 area.

USD/JPY – failed again at the 110.00 level yesterday, prompting a slide back lower. We also have key resistance up at the 200-day MA at 110.25, with trend line resistance at 110.50 behind that. Support remains back at the 108.70 area. A move beyond 110.50 opens up the 112.00 area.

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