The Pound to Euro exchange rate (GBP/EUR) tumbled by around half a cent from 1.1990 to 1.1940 yesterday afternoon as the European Central Bank kept interest rates on hold at 0.50% and struck a neutral tone with regards to future policy.
The single currency was also supported by news that Silvio Berlusconi was forced to take a U-turn on his attempts to bring down Prime Minister Enrico Letta’s coalition government after claims that a large group of dissenters within the media tycoon’s People of Freedom (PdL) party were considering abandoning his drastic plan to break-up the coalition. Subsequently, PM Letta received a massive 235-70 majority vote of confidence, meaning that Italy’s path to fiscal reform should not be interrupted. It also means that Berlusconi, and the volatility that he represents in the eyes of markets, could be banished from the Italian Senate as early as this Friday.
The Euro struck an 8-month high of 1.3607 against the US Dollar yesterday in reaction to the day’s positive developments. Although the single currency remains close to an 8-month low against Sterling at the moment, the possibility exists for a mini Euro revival if the ECB remains on the sidelines.
During his post-decision press conference ECB President Mario Draghi reiterated his commitment to keeping interest rates at the current record low, or lower, for a prolonged period of time. He mentioned that further rate cuts and additional LTRO measures had been discussed, but Euro sentiment was bolstered by the assertion that the ECB was not overly concerned with the Eurozone’s undershooting inflation rate.
Consumer Price inflation in the currency bloc recently printed at 1.1%, considerably lower than the ECB’s target of 2.0%, which led to talk of further stimulus but this speculation was dampened yesterday by Draghi’s less dovish-than-expected tone.
The single currency was also buoyed by comments from Draghi suggesting that the ECB would not specifically act to weaken the Euro because the exchange rate is not part of the Central Bank’s remit.
If the ECB continues to monitor Eurozone economic performance without feeling the need to spur credit growth or drive the bloc forward with further stimulus then we could see GBP/EUR retreat from its current strong levels. However, Sterling could easily assert itself above 1.2000 if Draghi sucker-punches the single currency with another bout of monetary easing.
With budget disputes effectively causing Democrats and Republicans to pull the plug on the US government, traders are beginning to speculate over the possible consequences of a catastrophic US default. If policymakers cannot agree to raise the debt ceiling by October 17th then America will default on its loan repayments, which could potentially call into question the US Dollar’s status as the world’s go-to safe haven currency.
Although policymakers are likely to pull through at the last minute, the closer the world’s largest economy gets to falling off the fiscal cliff, the more worried investors will get, which could potentially lead to further GBP/USD gains. A Pound to US Dollar exchange rate of 1.6300 is a distinct possibility.
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