Signs of stabilisation in the euro zone provided some respite for the euro, which has appreciated almost 5.0% since end-June (see daily chart, next page). Its climb, however, follows on the heels of a drop of similar magnitude in the prior month and highlights the vulnerability of so many currency to swings in sentiment. The economic situation in the region remains fragile, with confidence in those that have emerged from recession constrained by weakness in the periphery. Yet, while some individual economies may contract, the Q2 GDP report for the euro zone (released just after August 12) showed a modest 0.3% (q-o-q) expansion. Indicators for July suggest an extension in the recovery, while yields in the most distressed economies have started to come down. Inflation remains below 2.0% (y-o-y) in July and the European Central Bank has pledged to keep rates accommodative for ‘as long as needed’ in its recent statements. However, unlike the US or UK, the addition of ‘forward guidance’ in its communications comes without specific numeric thresholds. The euro could suffer more volatility, due to divergent growth and policy expectations with respect to the US. In addition, downside risks could come from political and institutional uncertainties, having seen negotiations on a banking and fiscal union stall.The consensus, on balance, is predicting that the currency will depreciate over the next twelve months.
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