European Central Bank stays hawkish as Athens burns
 
European Central Bank (ECB) governor Jean-Claude Trichet was speaking at the European Parliament in Brussels this morning and gave investors something other than Greece to focus on. He flagged a rate rise next week by saying that the Bank was in 'strong vigilance' mode regarding inflation. He said that current monetary policy is accommodative and that although inflation was caused by rising commodity prices, risks to prices remained on the upside.

The flash estimate of inflation for June was slightly lower than expected at 2.7 per cent, versus expectations of 2.8 per cent. However, this is still the seventh consecutive month where prices have been above the ECB’s 2 per cent target.  So the June data is unlikely to placate the ECB who seems willing to stamp out inflationary pressure and normalise interest rates even while peripheral economies struggle.

Currently there are two interest rate hikes priced in for the Eurozone, one next week and one in December. This compares with the US where a rate hike isn’t expected until April next year and the UK where the market doesn’t expect a rate increase until next May. So yield differentials remain supportive of the euro for the foreseeable future.

We will have to wait until Trichet’s press conference after the ECB rate decision next week to deduce the direction of policy for the rest of the year. We tend to think that the Bank will wait and see and normalise interest rates in a steady manner, although there is a chance the bank could hike rates in the third quarter, especially if price pressures don’t abate and growth in Germany remains strong. But while this remains a possibility, we think Trichet will be non-committal and signal that the Bank will pause and assess the economic conditions before making another decision on a rate hike.

There was more good news from Germany, unemployment fell further by 8,000 in June, and the unemployment rate remains at its lowest level for the best part of two decades. Although retail sales were weak in May, the annual rate remains at a healthy 2.2 per cent in Europe’s biggest economy. Consumption was weaker in France where consumer spending tumbled by 1.5 per cent in May.

We remain constructive on the euro in the near-term, and it remains in a technical uptrend above 1.4405. The single currency is testing 1.4500 – a key resistance level. Above here may see further gains.

There is further event risk today in Athens. The Parliament has to vote on the implementation of the austerity measures that passed yesterday. If this vote passes, as people expect, then this should be the green light for Athens to receive the funds it so desperately needs to stave off a default next month. This should be positive for risk.

However, Greece’s problems are not over yet, in fact they may just be beginning. The next tranche of bailout funds after this is due in September. So if Greece has failed to implement t these austerity measures we will have to deal with more default fears, more riots on the streets of Athens and more long, drawn out Parliamentary votes to enforce budget consolidation. So it could be a tedious summer ahead.

So far yesterday’s risk rally is continuing today in the European session with stocks higher along with the euro. The dollar has clawed back some gains this morning, and this is weighing on commodities since they are priced in dollars.

The pound has had a rough morning. Weak consumer confidence and housing data continues to dent sentiment towards the pound. Added to that quarter-end FX flows saw reported heavy buying of EUR/GBP, which added more downward pressure to sterling.

The Swiss franc is also lower even though the economy minister said that it isn’t the government’s job to deal with a strong franc, suggesting that there will not be direct intervention in the FX markets to stem franc appreciation.

Kathleen Brooks is research director at Forex.com

To receive more relevant articles like this one, why not sign up to our weekly newsletters, click here