London – 29^th June 2010

The single currency continues to be the currency market whipping boy as markets continue to adopt a risk-averse approach to currencies with sterling being one of the main beneficiaries of the Euros’ woes.

Widening CDS spreads and high interbank lending rates across Europe have increased funding pressures, with interbank rates at 7 month highs. There is also a potential liquidity shortfall of €100bn this Thursday as European banks have to repay €442 billion euros to the ECB on Thursday.

With debt auctions later this week in France and Spain, and rather weak demand for Italian paper yesterday, markets remain concerned about the solvency of EU nations.

The pound was boosted by comments from Bank of England Monetary Policy committee member Andrew Sentance who suggested that interest rates may have to rise sooner rather than later, despite the emergency budget, to deal with the current sticky level of inflation. The pound as a result hit its highest levels since September last year against a basket of currencies.

However the agreement to agree targets for cutting deficits in half by 2013 was about as good as it got, and considering a number of countries, including Britain and Germany, were implementing programs of this type in any case it didn’t really change anything from a risk point of view.

However the case for austerity was made quite clearly yesterday by the Bank for International Settlements, who stated that some countries did not have the luxury of waiting for a growth pick-up to begin the policy of fiscal tightening, and that stimulus withdrawal and the end of low rates could be the least worst option.

This approach has already been criticised by Keynesians who insist that stimulus must continue, however these people forget that with the current fragile state of investor confidence, the bond markets will impose fiscal discipline if governments are not strong enough to make the hard decision to implement it themselves, making any austerity much far more painful in the long run.

 As we come to the end of Q2 and into month end the dollar buying of the last few weeks has resumed, as the risk overhang from Europe continues to weigh on sentiment.

Today’s US data includes the Case-Shiller Home price index for April, but considering how bad the home sales figures were last week, the surprise will be if it’s even a remotely good number.

EURUSD – the single currency continues to find any progress above 1.2400 difficult to sustain in the short term as it continues to range trade between support around 1.2250/60, and the recent highs around 1.2400. A break above the June highs around 1.2460 targets 1.2750. The US dollar had lost some ground ahead of last weekend’s G20 on profit-taking on concerns that political leaders might actually achieve something from this $1bn junket.

With support remaining around the 1.2250/60 area, a break here would re-target the 1.2135/45 area. At the risk of sounding like a cracked record the long term outlook remains for a weaker Euro and a test towards the 2005 lows, around 1.1650, while below 1.2460.

GBPUSD – the pound continues to go from strength to strength breaking through the 1.5030/50 area and also trading above 1.5080, the 38.2% retracement of the down move from the high of this year at 1.6460 to the lows at 1.4230. This successful breach now opens the way for a move towards 1.5250 in the near term and possibly the 50% level of 1.5345. The pound should now find near term support around 1.4980, while there is also longer term support around 1.4740 and we could see a decline back towards these levels in the near term as short term momentum is starting to look a little stretched.

EURGBP – the break of the 0.8170 50% Fibonacci area yesterday has seen the single currency meet its near term target. However the failure to hold above it is a very bearish technical signal and we could well see further losses unfold over the coming weeks.  The single currency will continue to remain susceptible to rallies in the short term; however the break of 0.8170 now opens up the possibility of a test towards 0.8000 on the way to a test of 0.7785 over the coming months which is a 61.8% Fibonacci retracement of the same 3 and half year up move.We could well see rallies back towards resistance around the 0.8320/30 area in the meantime while behind that the key resistance remains above 0.8400.

USDJPY – the yen has continued to strengthen on the back of the recent return in risk appetite and as such has finally pushed below the 89.20/30 support area of the last few days. This break below 89.20/30 now re-targets a test of the flash crash lows of the 6th May at 87.95, though the dollar should find some initial support around the 88.70 area. The dollar should now find resistance at these previous lows at 89.20/30 and would need to see a rally back above the 89.75/80 area to re-target a move towards the 90.20/30 area.

Michael Hewson

Market Analyst

Market Comment

CMC Markets

Email:marketcomment@cmcmarkets.com