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The ECB kept interest rates unchanged today and offered no new measures to try and stem the sovereign debt crisis. ECB President Draghi said that the ECB is ready to “undertake OMT’s”, which will help to avoid the extreme scenarios, but that it is up to Spain etc to apply for financial assistance before this programme is activated. He also ruled out the prospect of near term rate cuts, saying that for most of the EMU real interest rates (once adjusted for inflation) are negative already.

No more action from the ECB

So the ECB is unlikely to enact any new policy action before the end of the year, unless there is a massive change of heart at the ECB, which we very much doubt. Added to this Spain seems even less likely to apply for financial assistance after a bond auction today saw Madrid reach its 2012 funding target. It also managed to sell a 20-year bond for the first time in over a year, which suggests that the sovereign environment in Spain continues to remain calm.

A warning from Draghi: no OMT without conditionality

Thus, it seems extremely unlikely that the OMT, the ECB’s most powerful tool to combat this crisis so far, will be activated before 2013. Even though the OMT still hasn’t been activated it dominated Draghi’s press conference. He wouldn’t grant the Spanish Prime Minister his request for the ECB to announce a cap on bond yields – so when yields reached a certain point the ECB would activate its bond purchase programme. Instead the ECB shot down any sense that it would enact the OMT without conditionality. The bond market reacted to this and Spanish bond yields are at their highest level for a month; the spread between Spanish and German bond yields reached 450 basis points earlier on Thursday, the highest level since early October.

Spain could delay applying for funds

Weighing on the bond market and risk sentiment in general is the perception that Draghi and co at the ECB do not seem to have any extra unconventional monetary policy support waiting in the wings. Draghi reiterated that the Bank does not pre-commit to policy decisions, thus it is unlikely to adopt a pledge to keep rates low for the long-term, which is the policy tool adopted by both the Fed and the BOE. Thus, it is hard to see how credit risk in the region can continue to fall especially when no one seems to be willing to take radical steps to activate the OMT. We expect yields to continue to move higher in the coming weeks. But Spain could hold off applying for a bailout until sometime in Q1 2013 as it has completed its funding requirements for 2012 already so that rising bond yields are less of an immediate problem for Madrid.

Since the ECB has not done anything to reduce credit risk further in the currency bloc it is hard to see the euro being able to sustain any rallies from here. But EURUSD remains tricky to trade right now and seems to be stuck in a medium-term range between 1.2610 and 1.2880 – the top and bottom of the daily Ichimoku cloud.

One to Watch: EURGBP

EURGBP has had a torrid week falling below 0.80. Support managed to hold at 0.7965 – the 50-day sma. We may see this pair consolidate between 0.7950 and 0.8030 – the high from earlier this week. We would be wary of selling this cross right now, although we believe the medium-term trend is lower.

Instead we could range trade into next week’s Bank of England Inflation Report. We will get the BOE’s latest growth and inflation forecasts and if these are revised lower then GBP may sell off. However, we continue to think that the UK’s growth outlook is more promising in the medium-term than the currency bloc’s and look for a move back towards 0.7800 in the medium-term in EURGBP. We would look to sell this cross on any strength back towards 0.8050.

EURGBP: daily chart


Best Regards,

Kathleen Brooks| Research Director UK EMEA |

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