Fundamental Forecast for Euro: Neutral

- EURGBP falls to and holds key support despite weak Euro-Zone data, ECB rate cut.

- Better than expected US data (3Q’13 GDP, October NFPs) at the end of the week kept the EURUSD pinned down.

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The Euro’s bullish momentum seen gathering since July – both fundamentally and technically – evaporated this week after the European Central Bank surprised market participants with a 25-bps rate cut. With the ECB’s main refinancing rate now at a new record low – and the same level of the Federal Reserve’s main rate – any carry advantage the Euro might have held against the safe haven currencies has diminished, tainting the appeal of the single currency.

The timing of the ECB rate cut comes at a curious time, with market participants widely expecting no change in policy (credit markets implied only a 4.1% chance of a 25-bps rate cut ahead of the meeting). Peripheral growth has remained weak in recent months, though off the lows; so to say that this policy decision was aimed at helping Italy or Spain, for example, is a bit far-fetched. A look at recent German data, though – month-over-month CPI came in at -0.2% for October – shows that the ECB rate cut is more or less a reaction to evidence of a slowing German economy.

Ironically, the Euro’s weakness the past two weeks may help alleviate the disinflationary and deflationary pressures starting to hit the region: a weaker currency will push up the cost of imported goods. Furthermore, a weaker currency will make peripheral exports appear cheaper to foreigners, as exchange rate differentials shift purchasing power abroad. Several months of a weaker Euro would do well to help the region pad its economic cushioning (even if the gains are superficial as a result of the ongoing currency devaluation wars).

Concurrently, the impact of the US Dollar on the Euro this week can’t be dismissed. Both the 3Q’13 GDP and October NFP reports exorcised US government shutdown demons, stoking a sharp uptick in US Treasury yields by the close Friday. With the “belly” of the US yield curve steepening the fastest, it appears that markets are starting to lean towards expecting a QE3 taper in December. As a result of these events and the ECB meeting, widening interest rate differentials – heading lower in the Euro-Zone and higher in the US – should favor further downside pressure in the EURUSD over the coming weeks.

Going forward, we have data out of the Euro-Zone this week that will immediately impact market psychology in the wake of the ECB. With deflation concerns afoot, the various 3Q’13 GDP readings due out this week (among others) will confirm or repeal those issues, offering opportunity for both EUR-positive and –negative outcomes.