Euro Optimism To Fizzle As ECB Talks ZIRP, Sterling Lacks Direction

Talking Points

• Euro: EU Proposes 'Bank-Specific Conditionality' For Spain, ECB Talks ZIRP
• British Pound: 1.5600 To Hold Up As Resistance, BoE's Posen May Spark 7-2 Split In MPC
• U.S. Dollar: Weakness To Be Short-Lived As Cyprus Stands Next In Line For Bailout

Euro: EU Proposes 'Bank-Specific Conditionality' For Spain, ECB Talks ZIRP

The Euro climbed to 1.2528 as European Union Economic and Monetary Affairs Commissioner Olli Rehn floated the idea of a 'bank-specific conditionality' for Spain, while a spokeswoman for the International Swaps & Derivatives Association talked down speculation that a Spanish bailout would ultimately lead to a credit event. At the same time, European Central Bank board member Jozef Makuch joined his colleague Ewald Nowotny and said that a zero-interest rate policy (ZIRP) in the euro-area could be feasible, but warned that lower borrowing costs would have 'a very limited impact' amid 'the environment in which monetary policy is conducted is characterized by an interbank market not functioning.'

In turn, the ECB may have little choice but to implement a range of policy tools to shore up the ailing economy, and the single currency may struggle to hold its ground ahead of the Greek elections as the EU struggles to stem fears of a euro-area break up. As the EURUSD maintains the range-bound price action carried over from the previous week, we should see the pair track sideways in the coming days, but we will maintain our bearish forecast for the pair as it struggles to push back above the 23.6% Fibonacci retracement from the 2009 high to the 2010 low around 1.2640-50. In turn, it seems as though there's limited scope of seeing a larger correction in the EURUSD, and we should see the pair resume the downward trend carried over from the previous year as the fundamental outlook for the region turns increasingly bleak.

British Pound: 1.5600 To Hold Up As Resistance, BoE's Posen May Spark 7-2 Split In MPC

The British Pound advanced to 1.5556 on Tuesday amid the rebound in market sentiment, but we may see the GBPUSD continue to find resistance around former support (1.5600) amid speculation for additional monetary support. Indeed, Bank of England board member Adam Posen struck a very dovish tone amid the ongoing weakness in the U.K., and we may see a 7-2 split within the Monetary Policy Committee as Mr. Posen turns increasingly pessimistic towards the economy. However, the majority of the MPC may continue to support a wait-and-see approach amid the stickiness in underlying inflation, but we should see the committee move away from its easing cycle as BoE officials anticipate to see a stronger recovery later this year. In turn, we may see the GBPUSD continue to consolidate between the 50.0% Fib from the 2009 low to high around 1.5270 and the 1.5600 figure, but sterling should continue to outperform against its European counterpart as policy makers in the U.K. take the appropriate steps to shield the U.K. from the debt crisis.

U.S. Dollar: Weakness To Be Short-Lived As Cyprus Stands Next In Line For Bailout

The greenback struggled to hold its ground going into the middle of the week, with the Dow Jones-FXCM U.S. Dollar Index (Ticker: USDOLLAR) tagging a low of 10,181, and the reserve currency may continue to give back the advance from the previous month as European policy makers increase their efforts to prop up market sentiment. As the economic docket remains fairly light for the remainder of the day, we should see risk-trends dictate price action across the major currencies, but trader sentiment may turn around going into the Asian session heightening finance costs across the European periphery continues to heighten the threat for contagion. Indeed, there's growing speculation that Cyprus is next in-line to request a bailout, and the ongoing turmoil in the euro-area will continue to dampen investor confidence as European policy makers maintain a reactionary approach in addressing the debt crisis.

--- Written by David Song, Currency Analyst

To contact David, e-mail dsong@dailyfx.com. Follow me on Twitter at @DavidJSong