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The recent spike higher in volatility has seen EURUSD fall back below 1.30 and European stock markets fail to get over stiff resistance levels.  The key driver for the declines have been fundamental: after a fairly quiet couple of months it has dawned on the markets that 1, the Eurozone crisis is not solved, 2, the ECB’s OMT programme has still not been triggered and 3, growth remains dismal.


This was the sentiment expressed by the German Finance Minister at a conference earlier this week. He said the markets should not get complacent as the worst of the crisis may not be behind us. He also said that economic reform efforts in the currency bloc need to be re-doubled to ensure trust in the euro.


However, economic reform efforts are going to be even harder as growth remains stubbornly weak in the currency bloc. The latest PMI surveys for October, released this morning, showed that the currency bloc had a very weak start to the fourth quarter of the year. The composite index (that includes both services and manufacturing surveys) fell to its lowest level since mid-2009. The October flash release is based on 85% of survey results, and is subject to revisions; however it seems likely that the Eurozone economy continued to decline this month.


Details of the PMI report:


The biggest decline came from new orders, although this sub-index recovered slightly from September’s fall, which was the largest decline since June 2009, it still does not bode well for future growth. Business activity declined at a slightly lower rate than September but it remains weak. Overall, the manufacturing sector continues to lag the service sector in the currency bloc.


Is France joining the periphery?


Employment indicators were also weak suggesting that unemployment, already at a record high in the currency bloc, has not found a bottom yet. In Germany the drop in the employment component was only marginal. Interestingly, the decline In France’s employment index was on par with levels that are broadly similar to the periphery. This may suggest a split in Europe’s core, with the German economy remaining fairly robust while the French economy drops back towards the periphery. However, the sharp decline in the French employment component could be a reaction to September’s austerity budget.

The core continues to out-perform the periphery, but we will be watching future French readings closely to see if the second largest economy in the currency bloc continues to exhibit traits more associated with the periphery. The PMI readings helped compound the bad news for France after dismal business confidence data was released yesterday.


Essentially the most up-to-date economic indicators suggest that new President Hollande has a problem on his hands in the form of weak Q4 growth (in his first quarter in office) and rising unemployment. The November surveys will be watched closely to see if France really is dropping back with the periphery or if the latest survey results were a reaction to Hollande’s budget last month.




The decline in the PMI survey does not bode well for growth in Q4 for the entire currency bloc, as the composite PMI has a very close relationship with GDP as you can see in the chart below.




The impact on EURUSD: medium-term outlook


Spain has been the key driver of the euro of late. The downgrade of five Spanish regions on Monday combined with the central government in Madrid’s unwillingness to apply for a bailout and the central bank’s assessment that the economy declined by 0.4% last quarter have helped to push EURUSD below 1.30. 1.2880 now looks like good support and may even attract some buying interest as the market prepares for a relief rally on the back of Spain bowing to the inevitable and applying for a bailout or line of credit and triggering the ECB’s OMT programme.


However, we believe any gains will be capped around 1.3175- 1.32 (September highs) as the focus switches back to growth. If France continues to register growth levels more commonly associated with the periphery this may spook investors and we could see a broader sell off in the euro. This would be bad news for EURGBP, as any concern about France may boost flow into UK Gilts, which may support the pound and could weigh further on EURGBP.


Thus, we would not be surprised to see EURGBP and EURUSD come under pressure in the coming months. 1.25 should act as good medium-term support for EURUSD, while 0.7930 – the base of the daily Ichimoku cloud - should act as good medium-term support for EURGBP.


Chart 1: EURUSD daily chart: below 1.2880 – the 200-day sma, opens up 1.2820 then 1.2750 in the near-term





Chart 2: EURGBP hourly chart: In the short term, we are starting to look oversold, so may bounce back towards 0.8110. However, we tend to think that strength will be sold into and look for a decline to 0.8020 and potentially 0.7990 on the back of contrasting growth fortunes for the Eurozone and the UK. Watch out for some volatility around the UK GDP release on Thursday at 0930, any upward surprise could see further weakness in this cross.







Best Regards,

Kathleen Brooks| Research Director UK EMEA |

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