The euro after rallying in the Asian trading session and hitting a high of 1.3950, fell back into its trading range from the last two weeks, falling to intra-day short term support at 1.3825. The EUR/JPY which also rallied in the Asian trading session fell back squarely within its range from the previous four trading sessions.

For a technical analysis look at EUR/USD see: EUR/USD in a Throwback from 1.3950; 1.38 is Key Support to Confirm Bullish Breakout

width=332While reports of the EU summit were generally positive in regards to proposals on hand, there were no firm decisions made on Sunday and that's created an opening for some doubt with traders easing off putting on any euro longs.

We therefore now have to await the summit on Wednesday in which will see decisions on a three-pronged attack involving recapitalization of European banks, substantial restructuring of Greece's debt, and a bigger bailout fund with possible fresh efforts to entice sovereign wealth funds as well as use the IMF.

Read: The 5 Keys to EU Summit #1 - Options for EFSF, Greek Haircuts, Bank Recapitalization and More...

Will markets yet again be disappointed by European politicians? The answer is yet to be decided.

Questions remain including the size of any Greek write-downs, whether private bondholder participation will be course or voluntary, in what way will the Europeans use the EFSF to support periphery bond markets, and where extra funds may come from? Some of the options include the aforementioned attempt to use China or maybe emerging markets funds via the IMF. With questions yet to be answered and uncertainty remaining, we're likely to see sideways trading till Wednesday, unless disappointment hits markets and causes a decline in the euro.

Manufacturing and Services Slow as Crisis Damages Real Economy

The fundamental data overnight from Europe was certainly a disappointment and showed how much the real economy is being affected by this most recent flare-up of the sovereign debt crisis.

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Preliminary readings on manufacturing and services activity from Germany and the overall euro zone for October predominately came in weaker than expected.

  • For the euro zone as a whole the manufacturing PMI registered a 47.3 reading compared to Septembers 48.5, and expectations of a 48.1 reading. That's two months a role of contraction in the manufacturing sector.
  • The services PMI registered a 47.2, below 48.8 in August, and expectations of a 48.6 reading.
  • For Germany the manufacturing PMI came in at 48.9, disappointing forecasts of a 50.0 reading and modestly weaker than Septembers 50.3.
  • In one positive surprise, Germany's services PMI registered a strong increase - posting a 52.1 reading compared to 49.7 in September, and forecasts of the only a slight increase 49.8.
  • The composite euro zone PMI eased to 47.2 in October which is the lowest level since September of 2009.

Weaker Economy Should Mean Lower ECB Rates

If manufacturing and services activity continues to contract, that will increase the forecasts for flat or negative growth in the euro zone in the fourth quarter and should add pressure on the European Central Bank to consider lowering interest rates from 1.5% before the end of the year. Such a move would help alleviate some of the pressures currently on the real economy.

A reduction of the ECB interest-rate would be bearish for the euro as it would lose some of its interest-rate advantage against lower yielding currencies like the dollar and pound, while widening the interest-rate differential between higher yielders such as the Australian and New Zealand dollars.

Nick Nasad
Chief Market Analyst
FXTimes