Euro in Focus as ECB Announces Interest Rates, Updates Economic Outlook (Euro Open)

The Euro takes center stage with the European Central Bank set to announce interest rates and update their economic outlook for the Euro Zone. UK Services PMI and EZ Retail Sales are also on tap.

Key Overnight Developments

• Australia’s Trade Deficit Widens as Stimulus Boosts Imports
• Euro, British Pound Range-Bound in Overnight Trading

Critical Levels

The Euro was confined to a narrow 30-pip range in the overnight session, trading sideways above 1.4260. The British Pound followed suit, oscillating in a 40 pip band above 1.6240.

Asia Session Highlights

Australia’s Trade Balance deficit widened much more than economists expected in July, showing a shortfall of –A$1.5 billion, the largest in 15 months. Preliminary forecasts ahead of the release had called for a –A$0.9 billion result. The previous month’s reading was also revised down to –A$0.54 billion from the –A$0.44 billion originally reported. The gap expanded as imports surged 4%, driven by a 21% increase in oil shipments. Imports of consumer goods advanced 2%, owing to overseas purchases of vehicles, food, and beverages. Exports fell 1%, led by a hefty 27% drop in cross-border gold sales. On the face of it, the data paints an encouraging picture of the Australian economy: rising oil demand (primarily in the form of industrial fuel and lubricants) points to an increase in production and hints at possible improvement in the employment situation while the increase in consumer demand is good news for the spending climate and thereby overall economic growth. However, not all is as rosy as it seems: much like yesterday’s surprisingly strong second-quarter GDP result, the surge in Australian demand evident in today’s data likely owes the government’s ample fiscal package, including A$20 billion in cash handouts to households and A$22 billion in infrastructure spending. Indeed, as we have previously suggested, the big question going forward will be whether the now buoyant Australian economy can maintain momentum once the flow of stimulus cash dries up.

Euro Session: What to Expect

The European Central Bank will take center stage in the coming trading session, with Jean-Claude Trichet and company expected to keep interest rates unchanged at 1% for the fourth consecutive month. The announcement’s market-moving potential rests on the bank’s update to its economic outlook for the Euro Zone, with any downward revisions likely to weigh heavily on the single currency. The currency bloc’s problems are well-documented. Deflation is becoming an increasingly real concern as CPI figures continue to print in negative territory. Unemployment continues to rise, threatening the outlook for spending and thereby overall economic growth. In fact, the pace of contraction in Retail Sales is set to accelerate to -2.2% in July. Finally, the banking sector is yet to come to terms with an estimated $1.1 trillion in unrealized sub-prime related losses (according to the IMF), a hit that could be compounded by defaults or devaluations in some of the newly-minted central European EU member states that are struggling with meeting their obligations to Western European lenders. Indeed, it is perhaps the prospect of these very losses that has undermined the ECB’s attempt to stimulate economic activity by allowing overnight borrowing costs to hover well below the 1% target level between 0.5 and 0.3 percent since June, with lending to the private sector growing at a record low 0.6% in July. The recent batch of economic indicators has painted an optimistic picture, boosted by a global wave of fiscal stimulus, broad inventory restocking efforts, and firming financial markets. How this will factor into the ECB’s world view rests entirely on whether the bank sees the current stabilization as the beginning of a sustainable recovery or a temporary reprieve.

In the UK, Services PMI is set to rise to 54.0 in August from 53.2.0 in the previous month, showing that the industry expanded at the fastest pace since February 2008. However, the analogous metrics for the manufacturing and construction sectors both disappointed, suggesting rising unemployment may be starting to become a meaningful drag on leading indicators and opening the door for a downside surprise in today’s report.

Written by Ilya Spivak, Currency Analyst
Article Source – Euro in Focus as ECB Announces Interest Rates, Updates Economic Outlook (Euro Open)