ECONOMETER

The European Central Bank (ECB) decision to embark on outright monetary transactions helped to provide a major lift to markets but did not spur the EUR onto major greater gains. The program of conditional albeit unlimited bond purchases was much anticipated and well received (except by the German Bundesbank) despite many of the details being leaked in advance. The lack of EUR reaction in part reflected this.

In fact, the EUR appeared to rally more in the wake of aggressive buying of EUR/CHF, which finally moved away from its 1.2000 floor, possibly with some official help. Markets will now await the decisions of Spain and Italy which would have to formally request aid for the bond buying plan to be put into action and perhaps there will be some hesitation on the part of the EUR to push higher.

Although there could be some nervousness ahead of the decision by the German constitutional court on the ESM permanent bailout fund and Dutch elections on 12 September the ECB’s move has provided a floor under risks assets over the short term. Given the EUR’s strong relationship with peripheral Eurozone bond yields, the implication is that the drop in the yields will provide some support for the EUR.

Before everyone becomes too excited it should be noted that there is still a long way to go before the Eurozone crisis will be resolved given the many structural and growth issues that need to be overcome. Nonetheless, the downside risks for the EUR are clearly diminishing, leaving the currency in better shape than it has been for a long while.

The fact that EUR/USD is back above its 100-day moving average is a positive signal. Moreover, despite some short covering the market is still very short EUR. However, we would be cautious about becoming overly bullish. Further gains in the EUR will be difficult to achieve given the constant drag on the currency due to relatively weaker growth and the simple fact that many of the underlying issues in the Eurozone remain unresolved.