Outside the dollar arena, forex traders are focusing squarely on Euro/pound (EUR/GBP). The pair rocketed 18 percent in December, surging to around 0.9800 on Dec. 29. The Euro has never traded at parity (1.00) with the pound, but the fundamental outlook for the UK is bleak.
“I think when traders come back to work in the new year they will push the momentum to test parity,” Ideaglobal analyst Kevin Chau says.
“We see that parity is an objective for market players,” says Michael Woolfolk, senior currency strategist at the Bank of New York Mellon. “Market sentiment islong Euro and short pound with an eye on an important psychological level.”
Expected central bank action and interest- rate differentials are playing a part in the recent trend.
“The European Central Bank [ECB] is going to drag its feet on cutting interest rates, while the Bank of England [BOE] takes continued aggressive action,” Woolfolk says.
The BOE is scheduled to meet on Jan. 8 and the market widely anticipates it will cut rates, which currently stand at 2 percent (expectations range from 0.5 to 1 percent). The ECB is also expected to slash rates, but at a more muted pace, at its Jan. 15 meeting. The ECB’s current repo rate is 2.5 percent. Analysts forecast a cut ranging from 0.25 to 0.50 percent.
ECB President Jean-Claude Trichet has been on the record with cautious statements that suggest muted interest-rate easing.
“The ECB has built a tremendous amount of market credibility by not shocking the market,” Woolfolk says.
In addition to interest-rate differentials, growth differentials also favor a continuation of the recent Euro/pound trend. Bank of New York Mellon is forecasting a 2 percent decline for UK 2009 gross domestic product (GDP) vs. a 1-percent decline for the Eurozone.
“The recession has not hit central Europe as acutely as it has hit the UK,” Woolfolk says.
Woolfolk, for one, sees the potential for the uptrend to extend beyond the parity level into the new year “until the ECB signals that it is prepared to adopt a zero interest-rate policy along with the U.S. and UK,” he says.
Finally, Woolfolk says recent trade data is also bullish for the Euro vs. the pound.
“The trade figures in the Eurozone are relatively stable and balanced, vs. a large trade deficit in the UK,” he says.
He says October 2008 data showed an EU trade surplus of €900 million vs. a deficit of £3.9 billion for the UK.
On the downside, Woolfolk cites .9250 as key support.
“If we were to close below that level, it would take out this bullish uptrend,” he says.
Woolfolk does warn of the potential for “buy the rumor, sell the fact” action around the early January BOE meeting and says traders “may get in early and take profits if the BOE does what they are expecting.”
But once the Euro/pound conquers the parity level in the weeks ahead, Woolfolk predicts forex traders will continue eyeing round numbers at 1.0100 and then 1.0200.
Woolfolk advises traders to watch for indications the ECB is considering a zero interest rate policy, which could prompt significant profit-taking.
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