European growth strengthens as sovereign woes persist

The big news of the morning was Europe’s growth data for the first quarter of the year. France and Germany registered stellar growth in the first three months of the year, which helped boost the overall Eurozone figure to 0.8 per cent; analysts had been expecting a 0.6 per cent reading. The annual growth rate in the currency bloc was 2.5 per cent, notably stronger than the US and the UK.

Although an International Monetary Fund report on the Eurozone economy released yesterday expects a soft patch in growth later this year, 2011 got off to a good start in the currency bloc. The performance in the periphery was mixed with Portugal falling back into a technical recession and Italy disappointing expectations. However, Spain did well and Greece was the largest surprise, its economy expanded by 0.8 per cent, the first positive reading for five quarters.

The euro has clawed back some ground this morning and has made a high of 1.4330 after the release of the German data. The single currency’s gains moderated slightly after the release of Eurozone-wide data (a little bit of buy the rumour, sell the fact), and the pair is currently just below 1.4300.

While sovereign concerns have started to weigh on the single currency, it was given some respite with the strong growth figures. However, the euro is also being driven by overall risk appetite and its bounce has coincided with strength in commodities and stocks and weakness in the dollar. Thus, the euro isn’t only moving in line with internal factors, but it is also getting affected by investors’ appetite for risk.

Thus, we believe that the single currency is exposed to more volatility in the near-term and are not expecting this period of respite to last, especially since EU finance ministers meet on 16 May (Monday) to discuss Portugal’s bailout package.

Elsewhere, EU leaders breathed a sigh of relief last night after Finland’s prime minister managed to squeeze out an agreement from his fractious and partly anti-European coalition partners to support Portugal’s bailout. This is important since it was necessary to get all EU members to agree to the bailout before funds can be dispensed to Lisbon.

Watch out for headlines from this meeting on Monday, since Fin Mins may also talk about a second bailout to Greece. This could affect investor sentiment towards the euro, especially after German European Central Bank member Ewald Nowotny told a newspaper today that Greece has not sufficiently fulfilled the conditions of its first bailout. German chancellor Angela Merkel has said that extra money will not be sent to Greece without further conditions, and she would wait until next month’s audit from the IMF before agreeing to a second bailout. This time last year, Germany’s reluctance to help Athens caused a rout in the euro, we will have to wait and see if the same thing happens again.

EU commissioner Ollie Rehn was speaking this morning and reiterated that risks to inflation were tilted to the upside but the European recovery is solid. The mix of strong growth/ sovereign fears is likely to keep the single currency volatile in the near-term, with 1.4500 the high for now, 1.4150 is still strong support.

The pound was weak across the board this morning after a report from the Institute of Fiscal Studies said that household incomes could return to 2005 levels, and that families have lost £500 of income over the last 12 months – the biggest drop in income since 1981. This does not bode well for growth going forward since the UK economy relies on consumers. This may keep the pressure on the pound into week-end.

Commodities are higher along with stocks after yesterday’s rout, the dollar is lower. We expect a bit of a pull back after the recent sharp moves lower in oil and silver in particular. We continue to believe there is further to go in this correction after risky assets got ahead of themselves in recent weeks. News from the Institute of Economic Affairs yesterday that showed a reduction in developed market demand for oil is likely to weigh on crude and product prices for some time yet. However, supply constraints still have the power to cause sharp spikes higher, so investors need to be wary.

The yen is higher, while the Swissie is neutral, suggesting that there is still some risk aversion in the market.

Ahead today CPI data and consumer confidence out of the US have the power to change the direction of the market as we head into the New York session. In the current environment this morning’s relative calm in the markets could turn volatile extremely quickly.

Kathleen Brooks is research director at Forex.com

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