Tough talk of interest rates will underpin the Euro initially, but internal divisions are liable to increase if the Euro-zone economy deteriorates further.

After consolidating around the 1.56 level on Monday, the US currency pushed stronger in New York trading. The Euro was undermined to some extent by report that a European institution was looking to buy a US bank which boosted optimism over possible capital flows into the US economy and the dollar strengthened to 1.5485.

The Euro was also unsettled to some extent by a generally downbeat set of German GDP growth forecasts from the Bundesbank. The central bank, however, also stated that inflation was unlikely to drop to any great extent until the Autumn of 2008 and this will tend to reinforce the tough stance from the ECB on interest rates, at least in the short term.

The dollar was unable to sustain the gains and weakened back to 1.56 ahead of Tuesday’s data. The German ZEW index improved slightly to -41.4 in May from -44.8 previously, but markets had expected a bigger improvement. The Euro weakened initially, but then secured renewed gains as the chief ZEW economist talked tough on interest rates with comments that the next move is likely to be an increase in interest rates.