While the US dollar has been weighed down by the political drama in Washington (page 3), the euro strengthened as Europe avoided similar stresses in governance. The Italian coalition avoided collapse, while German Chancellor Angela Merkel secured, as expected, another term at the recent national elections, albeit without an absolute majority. Policy continuity in the latter, though never really in doubt, has been confirmed, which should provide renewed impetus to regional projects that were stalled by uncertainty in Berlin. These include the formation of a ‘banking union’, which some describe as crucial to the recovery of investor sentiment and deeper integration of the euro. However, while political and economic sentiment has improved, providing scope to refocus on these long-term issues, critics warn of potential contagion from the peripheral economies. In particular, Greece and Portugal are among those that rely on cheap liquidity from the European Central Bank (ECB) and it is clear that they are not stable enough to withstand a withdrawal of credit. The ECB held rates unchanged last week but is under pressure to expand its Long-Term Refinancing Operation, a three-year scheme it introduced in December 2011. Unless further action is taken, bank repayment of these loans (as happened over the past month) would reduce excess money in the system and represent a tightening of monetary conditions.
You can download a sample of Foreign Exchange Consensus Forecasts at www.consensuseconomics.com.