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Monday January 28, 2008 - 12:03:26 GMT
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Forex Research - Euro Inches Higher But Money Supply Contracts - Can ECB Remain Hawkish Much Longer?

Monday, 28 January 2008 09:01:54 GMT

Written by Boris Schlossberg, Senior Currency Strategist

Euro-zone M3 money supply contracted for the first time in 4 months suggesting that slowdown in lending and business activity is spreading across the Atlantic.

Talking Points

• Japanese Yen: Drops below 106 on heavy Nikkei selling but pops back up during Europe
• Euro: Inches up above 1.4700 but M3 surprisingly lower
• British Pound: Trouble above 1.9800 as rate cut fears reappear
• US Dollar: New Home Sales today


Euro-zone M3 money supply contracted for the first time in 4 months suggesting that slowdown in lending and business activity is spreading across the Atlantic. The news pushed the euro off the day’s highs as the pair once again dipped below the 1.4700 figure in morning London trade. EZ M3 printed at 11.5% which was considerably lower than the 12.3% forecast as credit crunch conditions and equity market volatility exerted their toll.

The news took traders by surprise and EURUSD immediately plummeted 30 points before stabilizing and recovering back to the 1.4700 level. Double digit money supply expansion has been one of the key factors in ECB continued hawkish stance towards monetary policy as European monetary authorities have tried hard to curtail M3 growth.  Today’s data indicates that M3 may have finally reached an inflection point opening the way for ECB to begin easing in H2 of 2008.  

It’s too early to tell if the EZ has finally turned the corner on this issue – the three month average of M3 continued to grow at the fastest pace on record – but given the clear slowdown in price pressures in the region along with steady deceleration of consumer demand, European monetary officials will have a very difficult time making a credible case for further tightening should these conditions persist.

The EURUSD appears to have stabilized in the 1.4500-1.4700 area as traders look ahead to the two key event risks on the calendar this week- FOMC and NFP.  Trading in the pair this week is likely to be dominated almost exclusively by US news flow.  On the docket today are US New Home sales, which given the latest batch of housing sector data are likely to disappoint to the downside. However, the release may well be ignored by the market, as most of the bad news has already been priced into the pair. 

Instead speculation will center on Wednesday’s FOMC meeting as traders try to handicap whether the Fed will cut by another 25bp or 50bp. We believe US officials will opt out for only a 25bp cut having already eased rates by 75bp last week. If however, they choose to cut by 50bp the EURUSD is likely to gain as interest rate differentials between the two currencies will move deeply into euro’s favor. 

Is ECB too hawkish? Join us in the EURUSD forum.

If you would like to discuss this article with other traders or Senior Strategist Boris Schlossberg, please visit the DailyFX Forum

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Boris_Schlossberg 

To discuss this article please contact Boris Schlossberg, Senior Curency Strategist: bschlossberg@fxcm.com

 






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