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Rising euro poses a policy headache for ECB

It would appear that the policy of “America First” also means adopting a weak US dollar policy when it comes to trade after yesterday’s comments by US Treasury Secretary Steve Mnuchin in a snow covered Davos, invited a further avalanche of selling which saw the greenback hit its lowest levels since December 2014.

It does seem ironic that having come to office on a platform of accusing China of deliberately weakening or manipulating its currency the Trump administration appears to be doing exactly the same thing. It does make you wonder what the Chinese will say in response to the events of the last 24 hours?

The US dollar has been on the back foot for several weeks now, and while this week’s decision by the US government to impose tariffs on solar panels and washing machines didn’t help sentiment there was a belief that this was merely a negotiating gambit in order to exert some pressure with respect to upcoming trade negotiations.

This belief was undermined by some fairly punchy rhetoric from US Commerce Secretary Wilbur Ross which suggested that the US meant business and was prepared to take further measures if there was any retaliation.

While the slide in the US dollar is helping to underpin US equities with the Dow making a record close the effect on European equities was the exact opposite yesterday with the euro hitting new three year highs above $1.2400, which in turn along with concerns about trade tensions, helped send the DAX and broader European equities sharply lower.

The FTSE 100 also slipped back sharply after the pound had a strong day across the board pushing strongly through the 1.4000 level, and up to $1.4300 in Asia this morning the highest levels since the day after the Brexit vote. There was another positive catalyst in the form of some decent unemployment and wages data, which showed that employment levels were improving and wages were starting to close the gap with inflation.

A rising pound is also good news in terms of helping keep a lid on inflation, which continues to remain at elevated levels.

It is the exact opposite problem of the one facing ECB President Mario Draghi today when the European Central Bank meets to make its latest policy decision, against a backdrop of rising expectations of possible rate rises as early as next year.

With headline inflation remaining well below its 2% target rate at 1.4% and an economy that continues to show decent levels of economic activity the ECB is faced with having to navigate the minefield of guiding markets over the tightrope of communicating a credible timeline for stimulus reduction and interest rate policy, while trying to move CPI back to target against the difficulty of a rising currency.

Since the beginning of 2017 the euro has risen 18% against the US dollar and could well rise even further given yesterday’s remarks by US Treasury Secretary Mnuchin.

Last week ECB vice president Vitor Constancio along with Austria’s Ewald Nowotny expressed concern about recent exchange rate movements. These concerns are likely to have increased in recent days which will make today’s press conference by ECB President Mario Draghi much more interesting. He can’t very well ignore the improving outlook but if he comes across as too bullish the euro could well be well on the way to the 1.3000 level by the end of this quarter.

On the data front the latest German IFO business survey is expected to show a similarly upbeat tone to the recent PMI numbers staying close to its post-reunification record highs, just below 117.6 at 117.2.

EURUSD – the euro continues to push higher breezing through 1.2320 which now becomes a key support, as we look to push up the 1.2600 area and 61.8% retracement level of the 1.3995/1.0340 down move. Below 1.2160 argues for 1.2090.

GBPUSD – has continued to make further gains pushing past 1.4030 yesterday and closing in on the 1.4590 area, which is the 50% retracement of the 1.7190/1.1950 down move. The move higher has been a strong one and we could see interim resistance at 1.4330 but while above 1.4020 momentum remains positive, with interim resistance at 1.4330.

EURGBP – has continued to move lower pushing below 0.8740 and retesting the previous low in December at 0.8690. A break below here argues for further declines towards 0.8650. Short term resistance now comes in at 0.8750 and behind that at the 0.8800 area.

USDJPY – the break below the 110.10 area reopens up the lows at 107.30, having also broken below the 109.50 area. We need to move get back above 110.30 to stabilise and target a return towards the 111.00 area.

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