EU advance Q2 GDP will be released on Thursday, August 13th. The GDP report has the potential to spark volatility in EUR trade because the data is an important gauge of the strength of the EU economy and may impact ECB policy outlook. The trade expects EU Q2 GDP to show that the pace of contraction in the EU economy has slowed. The report is looked to for clues to whether the EU economy is nearing a bottom. EU Q2 GDP is expected to contract for the fifth straight quarter by 0.5% compared to 2.5% decline in Q1. EU annual GDP contracted by a record 4.9% in Q1.

In August the ECB elected to hold interest rates unchanged at a record low 1% and maintain its current program to buy €60 bln in covered bonds. In June the ECB increased lending to banks by €442 bln and extended its auctions from six months to 12 months in an effort to boost liquidity. ECB monetary policy is expected to remain on hold the remainder of the year. The ECB is unlikely to expand its asset purchases unless there is a significant deterioration in the outlook for the economy. ECB officials indicate that they see the pace of the EU economic contraction slowing and expect gradual recovery in 2010. Recent EU economic data appears to support the ECB's outlook for EU economy with manufacturing and services PMI at their best levels in nine months, consumer confidence at its best level since November and economic sentiment rising to a seven month high. Not all the economic news from the EU is improving. Unemployment continues to rise and inflation remains low. The EU unemployment rate rose to 9.4% in June compared to 9.3% in May. This compares to a 7.5% unemployment rate in June of 2008. German June CPI posted its first annual decline since 1995. ECB officials do not see risk of deflation in the EU and expect inflation to turn positive later in the year. The ECB expects the EU economy to contract by 4.6% in 2009 and rise by 0.3% in 2010 with inflation averaging 0.3% in 2009 and rising 1% in 2010. If the trend in EU inflation continues on a downward path and GDP remains weak the ECB may be forced to consider additional monetary policy measures to boost liquidity. The GDP report will be important to the debate over whether the ECB is correct in its optimism that the EU economy will gradually recover into 2010. A better than expected reading for the EU GDP could spark modest demand for the EUR and preclude the ECB from adopting additional measures to ease monetary policy. A bigger than expected decline in EU Q2 GDP would generate concern that the EU economy remains weak and spark fresh selling of the EUR.

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