Talking Points

  • Euro: Spain, Italy Face Record-High Financing Costs
  • British Pound: IMF Sees Scope For More BoE Stimulus
  • U.S. Dollar: Benefits From Risk Aversion, Data Disappoints

The heightening risk for contagion dragged on the Euro and the single-currency may face additional headwinds during the North American trade as the European policy makers struggle to restore investor confidence. The yield tied to Italy's and Spain's 10-Year bond advanced to a record-high on Tuesday and the ongoing rise in financing costs certainly dampens the outlook for the region as the economy faces a slowing recovery. In response, a spokeswoman for the European Commission said the two countries are 'taking the necessary actions to put their economies back on track,' and went onto say that the group is 'very confident' that Spain and Italy will not need a bailout as both countries remain 'committed' in aiding with the Greek bailout.

As growth and inflation cools, the slowdown in economic activity certainly makes it increasingly difficult for the EU to tackle the sovereign debt crisis, and the group could be forced to step up its efforts as the fundamental outlook for Europe remains clouded with high uncertainty. Although the European Central Bank is widely expected to keep the benchmark interest rate at 1.50% later this week, we may see President Jean-Claude Trichet continue to talk down speculation for higher borrowing costs, and the Governing Council may show an increased willingness to carry its unconventional measures into the following year as the debt crisis continues to weigh on the overall economy. In turn, the near-term reversal in the EUR/USD looks as though it will gather pace going into the middle of the week, and the pair may threaten the rebound from 1.3836 as interest rate expectations falter.

The British Pound continued to trade heavy as the economic docket showed a slowing recovery in the U.K. and the Bank of England may show an increased willingness to expand monetary policy further in order to balance the risks for the region. The International Monetary Fund said the U.K. economy is expanding at a 'moderate' pace, but would need additional stimulus should the region continue to face a protracted recovery. As policy makers see a risk of undershooting the 2% target for inflation, we may see a growing shift within the MPC, but the committee will certainly refrain from releasing a statement this week as the central bank is widely expected to maintain its current policy in August. In turn, market participants will certainly keep a close eye on the BOE minutes, which are due out on August 17, but the quarterly inflation report coming out on the 10th could take the steam out of the policy statement as we get an update on the central banks economic forecast. In turn, the GBP/USD may consolidate further in the days ahead, and the exchange rate may trade within a broad range over the near-term as investors weigh the outlook for monetary policy.

The greenback gained ground as U.S. policy makers took extraordinary steps to avert a default, and the dollar may continue to recoup the losses carried over from the previous month as the government looks to address the ballooning budget deficit. However, the recent developments coming out of the world's largest economy appears to be weighing on trader sentiment, and the shift away from risk-taking behavior may gather pace over the near-term as the fundamental outlook across the globe remains clouding with uncertainties. As equity futures foreshadow a lower open for the U.S. market, risk aversion should gather pace throughout the day, and we should see the greenback continue to appreciate as it benefits from safe-haven flows.