Euro Steady Ahead of ECB As Deflation Threat Looms

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Market Drivers for December 5, 2013
Majors in tight ranges ahead of CB meetings
Aussie trade balance worse
Nikkei -1.50% Europe .19%
Oil $97/bbl
Gold $1233/oz.

Europe and Asia:
AUD Trade -.5M vs. -3M

North America:
EUR ECB Presser 8:30
USD GDP 8:30
USD Weekly Jobless 8:30
CAD Ivey PMI 10:00

The euro remained well bid, trading near the 1.3600 level in early European session today ahead of the key ECB meeting later in the day. The pair jumped to a high of 1.3638 in a low liquidity short squeeze in Asian dealing but quickly gave up its gains as traders remained cautious awaiting the ECB press conference at 13:30 GMT.

Although few market observers expect any meaningful policy changes, especially after last month’s surprise rate cut that lower the benchmark rate to 25 basis points, traders will be keenly tuned in to any change of rhetoric from ECB chief Mario Draghi. Several analysts have pointed out that the EZ is teetering on the edge of deflation as price levels have declined well below the target rate and money supply growth has decreased to just 1.6% versus 4.5% targeted by the central bank.

The EZ economy remains highly bipolar with Germany doing well, but the rest of monetary union trapped in a deflationary cycle that has frustrated any attempts at recovery. Even France which just a few years ago was seen as part of the core European growth engine is now acting much more like the Club Med economies of Spain and Italy as growth continues to elude it.

The key danger of deflation as many analysts have pointed out is that is exacerbated the region’s sovereign debt problems by making real interest rates higher while at the same time contracting the base of revenue. That’s why it will be interesting to see if Mr. Draghi addresses any of these concerns in the press conference today as he provides ECB estimates for growth in 2014 and 2015.

Additionally the ECB has been relatively sanguine about the recent strength of the euro as it hovers near yearly highs against both the dollar and the yen. For an export centric economy like the Eurozone the appreciating currency has served to stymie any attempts at growth. Up to now the ECB position has been essentially to ignore the exchange rate differentials stating that its mandate is focus on price stability. However, with many G-7 central banks continuing to practice the policy of defacto devaluation, the ECB may have no choice but to jawbone the currency lower.

If Mr, Draghi does indeed strike a dovish tone at the presser and even brings up the possibility of negative rates the EUR/USD could quickly tumble out of its tight range and break below the key 1.3500 level as the day proceeds. If however, Mr. Draghi remains dismissive of the current deflationary threats and high exchange rates, the pair could squeeze towards the key 1.3700 level as momentum flows propel it higher.

Boris Schlossberg
Managing Director

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