Political uncertainty in Spain, Italy not expected to prevent further euro gains

Despite rising political uncertainty in both Spain and Italy the recent strength in the single currency has continued unabated, with investors choosing to focus on the shrinking balance sheet of the European Central Bank, and recent repayment of LTRO money, in direct contrast to both the central banks of the US and Japan who seem intent on continuing to inflate theirs higher.

Friday’s US employment report on the other hand has reinforced optimism about the underlying strength of the US economic recovery sending the Dow to within touching distance of its all-time highs in 2007, and generally continuing the positive momentum seen in European markets over the past month.

Last week we saw European unemployment data for December stabilise slightly, however it continues to remain at frighteningly high levels, Germany notwithstanding, while manufacturing data also appeared to be showing some evidence of bottoming out.

Today’s we see the problem of unemployment shift back to Spain with the release of the latest Spanish unemployment data for January and after a decline of 59k in December we could well see another large jump to the tune of 150k job losses. The Spanish government has already been in the spotlight over the past few days due to the on-going payments scandal currently implicating a number of senior politicians, including Prime Minister Rajoy himself.

Despite these events in Spain and the recovery in the Berlusconi vote in Italy ahead of this month’s Italian election, bond markets in both countries have remained largely unaffected, if not a little complacent.

If markets continue to push the single currency higher then this week’s ECB rate meeting could well be an important indicator with respect to calls for a rate cut. Last week we saw euro area inflation hit a two year low, which, on the face of it, would seem to suggest that the ECB does have room to cut rates.

Unfortunately a rate cut seems highly improbable given the tone of Draghi’s comments at last month’s press conference, which would seem to suggest that we could well see further gains, which in turn would be bad news for the weaker European economies.

As a result the pound amongst others has taken an absolute pasting, losing 5% of its value against the resurgent euro in the past month alone.

Deteriorating economic fundamentals in the UK, a lack of growth and the likely loss of the triple “A” rating has seen traders head for the exits and this morning’s construction PMI for January is not expected to paint a particularly great picture, though we do expect to see an improvement to 49.7 from December’s 48.2.

EURUSD – last week’s close above the 200 week MA appears to be setting up a potential move towards 1.3835, the 61.8% retracement level of the 1.4940/1.2045 down move. Pullbacks should find support at 1.3400, while below that we have the 1.3250 level the January lows. The long term support line from the 1.2045 lows now comes in at 1.3110 which remains the key level on the downside. .

GBPUSD – another disappointing week last week keeps the pressure on the downside with the key support remaining at 1.5680 the 61.8% retracement of the 1.5270/1.6380 up move. There is also long term trend line support at 1.5630 from the 2009 lows at 1.3500, a break of which opens up the 2 year range lows at 1.5270.
The pound needs to close back beyond the 200 day MA at 1.5910 to stabilise and diminish the downside risk.

EURGBP – the break beyond trend line resistance at 0.8605 from the 0.9805 highs has triggered further gains and could well see a move towards 0.8830 and the October 2011 highs. The 200 week MA and 0.8525 level should now act as support on any pullbacks, with only a push below re-targeting the 0.8425 area. Long term trend line support at 0.8115 comes in from the 0.7755 lows.

USDJPY – no let up here as the US dollar closes in on the 94.00 level, which is 38.2% retracement of the down move from the 2007 highs at 124.15 to 75.30. We also have resistance at 95.00 which is the 2010 highs.
Only below the 90.30 level argues for a deeper correction towards key support at 87.50.