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QE3 speculation increases

Forex Analysis - 5th July 2012

Written by Imran Allana


The past few days has seen significant market activity in the wake of last week’s two day European economic summit. Market expectations were low for any meaningful outcome leading in to the meeting, however some progress was made with regards to creating a single bank supervisor for eurozone banks with European Central Bank (ECB) involvement, a recapitalisation of weak banks using the European Stability Mechanism (ESM) and a 120bn euro stimulus to boost growth. Additionally, the decision to prioritise ESM loans lower than other debts was made to help avoid panicking private investors. Although many other things were not agreed, the progress made on the last day of the summit was enough to bolster the market. We saw large rallies from both gold and EUR/USD, the latter jumping around 200 pips from the middle of the Asian session to midway through the European session. With gold, much of the movement higher has been attributed to safe haven buying, as well as some short covering and speculation of a third round of quantitative easing (QE3) from the US.

In to the US, speculation has increased considerably concerning the Federal Reserve’s intention for implementing another round of quantitative easing. Economic reports such as the Purchasing Managers Index (PMI) have been weak and further data has revealed the American economy is not expanding at a healthy rate. The Fed could be forced to implement QE3 in the wake of Friday’s release of the Non-Farm Payrolls (NFP) data.

Similarly, the Bank of England (BoE) is due to reveal their asset purchase facility figure later today which is expected to be raised from £325bn to £375bn. Some market participants were expecting this to happen last month but were disappointed when the BoE decided to hold off any increase. If this raise is announced, we may see a weaker sterling against all pairs. The ECB is also due to announce interest rates today and a cut of 25 basis points is expected. Such a cut may result in a mixed reaction with some investors viewing it as a step in the right direction and others viewing it as further euro weakness. With the various central bank announcements and given that there was a bank holiday in the US yesterday, the markets are gearing up for more volatility today and tomorrow.

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