Euro Weighed By Threats Of Credit Rating Downgrade, ECB Split

Warning shots fired by Moody’s Investor Services rattled market sentiment on Monday, and the shift away from risk-taking behavior may gather pace over the coming days as the fundamental outlook for Europe turns increasingly bleak. 

Talking Points

• Euro: EU Unveils New Fiscal Pact, Moody’s Cuts Rating On French Banks
• British Pound: Producer Price Inflation Cools, Further Easing Ahead

Euro: Moody’s To Review EU Credit Rating, ECB To Stick To Standard Policy

The Euro tumbled to a low of 1.3229 after Moody’s highlighted an increased risk of seeing ‘multiple defaults by euro area countries’ paired with exits from the monetary union, and the single currency is likely to face additional headwinds over the coming days as the agency threatens to lower its credit rating for the euro-area. Indeed, it seems as though market participants are turning increasingly pessimistic towards the region as the new accord raises the risk of a deep recession, and we may see the governments operating under the fixed-exchange rate system become increasingly reliant on monetary support as the economic recovery in Europe deteriorates.

However, Bundesbank President Jens Weidmann talked down speculation of seeing the European Central Bank expand its role in addressing the sovereign debt crisis, and it seems as though we will see the Governing Council continue to move away from its nonstandard measures as there appears to be a growing rift within the central bank. In turn, we may see ECB President Mario Draghi take the benchmark interest rate below 1.00% in 2012, but the board may have little choice but to further expand its asset purchase program as European policy maker struggle to restore investor confidence. As the EUR/USD gives back the rebound from 1.3145, the recent downturn in market sentiment could push the exchange rate below the 38.2% Fibonacci retracement from the 2009 high to the 2010 low around 1.3100, and the euro-dollar looks poised to trade heavy over the remainder of the year as the fundamental landscape for Europe turns increasingly bleak.

British Pound: BIS Talks Down QE Impact, Slower Inflation On Tap

The British Pound bounced back from an overnight low of 1.5536, but the sterling may struggle to hold its ground over the next 24-hours of trading as the economic docket is expected to show easing price pressures in the U.K. As the headline reading for inflation is projected to increase at an annual pace of 4.8% in November after expanding 5.0% in the month prior, and the slower pace of price growth is likely to weigh on the exchange rate as market participants see the Bank of England further expanding its Asset Purchase Facility in the following year. However, the Bank of International Settlements argued that quantitative easing may have a limited impact in stimulating the economy as bond yields ‘are already very low,’ and warned that it may be difficult for the BoE to unwind its balance sheet ‘in a way that does not roil markets’ as investor confidence remains frail. Speculation for more QE instills a bearish outlook for the sterling, and we expect to see the GBP/USD weaken further over the coming days as the economic outlook for the U.K. falters.

More to Follow...

--- Written by David Song, Currency Analyst

To contact David, e-mail dsong@dailyfx.com. Follow me on Twitter at @DavidJSong

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EUR/USD incurs in new lows

 After one more plunging during the American opening reaching 1.3232 low, the EUR/USD retraced for a while, but a new selling wave is hitting the pair to new lows for the day. The market is addressing the cross to Nov-25 low, at 1.2312.

As Wells Fargo analyst Nick Bennenbroek states: “In the near-term and ahead of that implementation, the risk of further weakness in the euro along with other G10 and emerging currencies remains”.

“Initial resistances lie at 1.3280/1.3300, ahead of 20 day SMA, currently at 1.3320 and maintaining bear-tone”, says Windsor Brokers analyst Slobodan Drvenica, that points supports at 1.3229, 1.3211, 1.3200 and 1.3145. 

UK rejects EU deal on fiscal discipline, remains isolated

The two day long EU summit concluded on Friday in an atmosphere of division as not all of the EU Member States agreed to join the Eurozone 17 in preparing an intergovernmental treaty on tightening the fiscal union.

When the official talks finished, the President of the European Council Herman Van Rompuy announced that the UK is the only EU country which will not take part in drafting the new rules on fiscal discipline.

British PM David Cameron said it was a tough decision, but a right one, because the treaty was not to UK's best interests. He expressed his hope however, that the Eurozone manages to solve its problems: "We want the euro-zone countries to come together and solve their problems, but we should only allow that to happen inside the European Union treaties if there are proper protections for the single market and for other key British interests."

European Commission President Jose Manuel Barroso regretted after the meeting that an agreement including all EU nations was not reached: “We would have preferred a unanimous agreement. This was not possible.” He also added that “the only alternative was to do it via an inter-governmental treaty, but that doesn’t mean that EU institutions won’t have a role.”

Herman Van Rompuy also confirmed that EU countries will provide the IMF with 200 billion euros, although he did not specify how will these resources be used exactly and said that EFSF firepower will be boosted as soon as possible, with the aim of activating it by July 2012. The President of the European Council added that the issue of eurobonds remained unsolved, but works on the matter will be continued.

EU leaders fail to change Treaty after first day of talks

The EU officials gathered in Brussels for the last summit of the year, considered to be crucial for the future of the euro, have concluded their first day of negotiations at five in the morning on Friday, after ten hours of talks. European leaders managed to agree on a fiscal pact which will increase budget discipline in the area, but failed to introduce the changes to the Treaty.

The EU politicians reached an agreement on making anti-deficit rules stricter, in hope of convincing the ECB to accelerate its rescue operations, after Mario Draghi emphasized at a press conference following the central bank's interest rate decision on Thursday, that it would not step in to help out the struggling EU government bond markets. The so-called 'fiscal compact' includes sanctions for countries breaching limits of deficit and public debt.

European Council President Herman Van Rompuy, who also chairs the summit, explained the decision during a press conference at the end of the meeting: “"It means reinforcing our rules on excessive deficit procedures by making them more automatic. It also means that member states would have to submit their draft budgetary plans to the (European) Commission,"

Meanwhile ECB President Mario Draghi expressed his satisfaction with the decision: “It’s a very good outcome for euro-area members and it’s going to be the basis for a good fiscal compact and more disciplined economic policy in euro-area countries.”

The “fiscal compact” will be implemented by the 17 Eurozone countries and 6 other members of the European Union. The deal could not be sealed by all 27 EU countries due to the fact that the British PM David Cameron presented demands which Germany and France were not willing to fulfill – a right for the UK to veto EU laws concerning financial market services. Also the Czech Republic, Hungary and Sweden refused to join the “fiscal compact.”

Other issues discussed during the meeting was the possibility EU central banks lending €200 billion euros (150 billion euros from the Eurozone) to the IMF which the institution could in turn use to strengthen the crumbling bond markets.

"We can be very pleased at the result," said IMF Managing Director Christine Lagarde leaving the summit.

EU officials decided as well to limit the permanent bailout fund, the European Stability Mechanism, at 500 billion euros, and excluded the possibility of granting it a banking license, as it was previously suggested by Herman Van Rompuy.

Paul Donovan form UBS seems to be skeptical about the decisions taken at the summit so far, which he considers a flash in the pan: “The IMF may get a loan of 200 billion euro. The ECB will administer the EFSF and ESM bailout mechanisms. Does this solve the crisis? Imposing a pro cyclical fiscal policy on a pro cyclical exchange rate and monetary policy without tackling competitiveness issues does not solve the larger crisis, no. It may buy time.”


The statement by the Euro area head of state was released afterward.

ECB adopts more unconventional measures to fight the crisis

After the ECB's decision to reduce the interest rate by 25 basis points to 1% in December, the central bank's President Mario Draghi held a monthly press conference to comment on the considerations underlying this move and announce steps which the institution will take, in order to contain the EU debt crisis.

The first of the new measures introduced by the ECB are two non-standard operations which offer unlimited 36-month credit for banks in the Eurozone, with an option of early repayment after one year. The second is an increase of collateral availability of ECB loans by means of reducing the rating threshold for certain asset-backed securities (ABS). The third measure concerns a decrease of the reserve requirement for commercial banks from 2% to 1%, which is supposed to free up collateral and support money market activity.

Following the ECB meeting Draghi told the reporters that the above-mentioned steps taken by ECB “should ensure enhanced access of the banking sector to liquidity.”

Apart from presenting the new measures, Mario Draghi firmly rejected the possibility of the ECB
purchasing unlimited amounts of bonds of the most indebted EU countries as well as lending money to the IMF in order to evade EU regulations, according to which central banks cannot finance Eurozone governments.

Jamie Coleman from Forex Live comments on the ECB's unexpected decision: “The market came to the very logical conclusion after Mr. Draghi testified before the EU Parliament last week that if the EU did its part to get its fiscal house in order the ECB would do its part from a financial perspective. Perhaps we read too much into the comments, but they seemed quite straight forward. makes you wonder why the Germanic shift in the last week. Some would say "they" got to him, they being the Germans...We may never know... What we do know is that the ECB will be part of a quick-fix for the euro zone making any recovery that much more difficult.”

In hindsight, UBS FX strategist Geoffrey Yugiven commented: "There were no signs of any breakthroughs ahead of the European Union summit, the ECB was always going to keep its strongest cards close to its chest and not risk its own credibility. If they acted according to the market's wishes, the incentives for governments to act would almost evaporate and the central bank was not going to let that happen."