KBC Sunrise Market Commentary: ECB will keep policy unchanged

After the ‘suspect’ flaring up of risk appetite on Tuesday, investors didn’t know whichcard to play yesterday morning. Asian and European equities joined the correction inthe US from Tuesday evening. As was the case for the rebound on Tuesday, therewas again no obvious explanation for this reversal. Global dollar weakness playedstill a role (the trade-weighted dollar continued to drift south), but the picture wasless clear. EUR/USD was dragged lower and reached an intra-day low more or lesswhen the German factory orders were published. The report showed a slight declinein the May orders. However, it would be over-interpretation to the link the price actionon the currency market to the outcome of this release. Going into the US tradinghours, European equities tried to move away from the lows and this put a floor for theeuro. EUR/USD returned to the 1.2600 area. Later in US trading, risk appetite wasback in town. Equities rallied (again on no high profile news) and EUR/USD stagedanother up-leg. The pair tested the 1.2662 (Tuesday high)/1.2673 (May high) resistancearea, but the test failed. The pair closed the session at 1.2638 compared to1.2626 on Tuesday.

No high profile news for sterling trading. Recently, cable underperformed EUR/USDas the sterling positive impact of the inflation debate within the BoE (as revealed inthe Minutes of the June meeting) faded. This triggered a correction on the rally of sterling against the euro and EUR/GBP reached a correction high at 0.8341 on Tuesdayevening. This correction/rebound slowed yesterday, but there was no new storyto take over. So, in technically inspired trading, the pair lost a few ticks and closed thesession at 0.8321, compared to 0.8334 on Wednesday.

The correction on the equity markets initially kept most ccy/yen cross rates underpressure. USD/JPY came very close to the 87.00 mark (and thus also the year low at86.96), but no real test occurred. Late in US trading, the pair finally managed to takesome advantage from the rebound on the US equity markets. The pair closed thesession at 87.70, compared to 87.52 on Tuesday evening. Nevertheless, yesterday’sprice action was still rather disappointing for USD bulls as the gain was only limitedgiven the gains on the equity markets.

This morning, Asian markets play the risk theme again. Equities show decent gainswith Japan outperforming. China is the exception to the rule. The ccy/yen cross ratesincluding USD/JPY are moving away from the recent lows. If sustained, this morning’srebound could be a first sign that the test of the downside in USD/JPY is finallyrejected.

Today, the US jobless claims will get some attention form the markets. After lastweek’s disappointing payrolls, markets will continue to look out signs of weakness inthe labour market (and in the global economy). From a currency point of view, thekey question remains whether markets, in case of poor US data, will play thecard of risk aversion (euro negative) or dollar weakness. The jury is still out onthis issue and we doubt the claims will be able to force markets to make their choicein this debate.

The key event today will be the ECB press conference (cf. our flash report). Lastmonth, there were several ‘hot issues’ for Mr. Trichet (bond purchases, uncertainty onthe impact of the expiration of the 1-year liquidity tender). However, even as theEuropean financial crisis is far from over, the stress has diminished recently. So, onemight expect the ECB President to stay low profile going into the summer holidays.Regarding the currency market, the euro has regained quite some ground since theJune meeting. So, Trichet will probably get no ‘difficult’ questions on the pace of thedecline of the euro. Questions on the stress tests for European banks might be awildcard for some outside risks of market volatility. So, we don’t expect much fromthe ECB meeting for currency trading. Watching equities and the technical picture willremain the name of the game for EUR/USD trading. EUR/USD is now testing the1.2673 resistance area. Equity investors are apparently preparing for a good earningsseason and this is also supporting the euro. We are still a bit reluctant to jump onthis rebound (both for equities and EUR/USD) as there is no convincing story to supportit. Nevertheless, sustained trading north of the 1.2673/1.2695 (Reactionhigh/Long-standing downtrend line since December) would be a technical sign thatthe correction might have some further to go.

Sterling traders will keep an eye on the industrial/manufacturing production data.The outcome of this series might help markets to decide whether the recent correctionin EUR/GBP has some further to go. There will also be a lot of market chatter goinginto the BoE meeting. However, the BoE is widely expected to stay on hold. Nextmonth’s meeting will be key as the BoE will have a new inflation report then. Investorswill have to wait for the minutes of today’s meeting (July 21) to get any further insightin the internal inflation debate of the BOE and to see whether dissenter Sentencehas additional support within the MPC. So, we don’t expect any impact of theBOE meeting on sterling trading.