EUR/GBP: Dampened Talks of Further Stimulus Boosts the Euro

The Euro is likely to maintain its gains opposite the British pound today after European Central Bank President Mario Draghi delivered an optimistic outlook for the Euro Zone economy later this year, dampening talk of additional rate cuts. Meanwhile, the Bank of England also kept interest rates and its Asset Purchase Program on hold yesterday, but analysts warn of another sluggish year ahead.

After unanimously holding interest rates at a record low, the ECB said that the Euro Zone economy will recover later in 2013 amid signs of stabilization. The ECB left rates at 0.75 percent, following tentative signs of life in the economy, prodding Draghi to strike a more optimistic tone. The ECB was united in its decision, he said, because some indicators had begun to stabilize while financial market confidence had improved significantly. Draghi further declared that “positive contagion” is helping to drag the Euro Zone out of its crisis and expressed confidence that a gradual recovery would begin this year. He also said that the improved health in the financial markets should work its way through the economy and that foreign demand should strengthen, providing a boost to exports.

Speaking to reporters, Draghi hailed that the Euro region has turned a corner in its crisis fight, citing a sharp drop in bond yields across the Euro Zone, a stock market rally, recovery of bank deposits in Greece and Spain, and stronger capital inflows. Indeed, fresh signs of improved sentiment emerged yesterday after Spain’s benchmark bond yields fell to 10-month lows yesterday after a strongly-bid auction. Spain sold 5.82 Billion Euros worth of bonds, exceeding the 4 to 5 Billion Euros targeted. As such, two-year yields fell 26 basis points while 10-year yield dropped below 5 percent for the first time since March 2012. With the ECB seemingly signaling that no further rate cuts are expected, the common currency is seen to strengthen.

Meanwhile, the Bank of England also decided to keep interest rates unchanged and held its stimulus program at 375 Billion Pounds yesterday amid a dismal economic outlook for this year. BOE governor Mervyn King warned in November that the economy would continue its zigzag pattern and that a recovery would take some time. The dominant services sector contracted for the first time in two years in December, raising fears that the country could be on the brink of another recession. Consumer confidence also deteriorated while the British Retail Consortium called the holiday sales “underwhelming.” On views that another injection to the APF is likely in the early part of 2013, the Sterling is apt to decline. Hence, a long position is advised for the EUR/GBP trades today.

Aviv N. Shapiro is a Senior Research Analyst and Business Development Officer for AlgosysFx.