The Euro has emerged over recent weeks as one of the strongest of the major currencies and this has been felt particularly acutely against Sterling. This time last year the Euro zone was engulfed in the early stages of the Sovereign debt crisis. Pundits, analysts, economists and almost anyone with a view on the Euro zone was queuing up to forecast the death of the Euro and break up of the Euro zone. What’s changed?

TECHNICALS:

WEEKLY CHART
The market has completed a bull falling wedge – using the bull momentum from a completed Head and Shoulders reversal…..if the market can establish itself above the Prior High at 0.8955 that would act to drive the market on further still.
The violent bear move of today broke back through both the 0.8955 support and the 0.8922 support….
But the bull diagonal support is in place and beneath that the neckline support at 0.8780 or so.
We remain bulls of the Euro.
FUNDAMENTALS:
The Euro has emerged over recent weeks as one of the strongest of the major currencies and this has been felt particularly acutely against Sterling.
This time last year the Euro zone was engulfed in the early stages of the Sovereign debt crisis. Pundits, analysts, economists and almost anyone with a view on the Euro zone was queuing up to forecast the death of the Euro and break up of the Euro zone.
One year later, the Sovereign debt crisis goes on, with no end in sight, but people are no longer forecasting the Euros death, to the contrary, it is enjoying a period of strength.
The transformation is all the more amazing when contrasted with Sterling and the way the UK government has decided to deal with the UK debt build up under the previous Labour administration.
In the Euro zone countries have adopted a degree of fiscal rectitude, especially those seeking financial rescue, but sometimes at the expense of growth.
In the UK, the coalition government has put in place one of the harshest peace time fiscal tightening’s of modern times in an attempt to reduce the budget deficit and reduce the debt to GDP ratio.
Their rationale was; the Country was living well beyond its means and judged action was needed before the rating agencies downgraded the UK’s sovereign debt and Bond markets forced UK long term yields up to levels that would make the debt difficult to service.
At first glance one would think the Pound would garner support from such a policy, but no. The government knew there was a risk the economy would weaken, even slip back into recession, but judged the gamble unavoidable, and although the economy hasn’t slipped into recession, it has clearly weakened and this is undermining the Pound.
Traders are worried that if the economy weakens much more from here there are few policy levers available to add support. Interest rates at 0.5% are already rock bottom, and the Bank of England seems set to leave policy on hold for several months yet, even as inflation stands at double the mandated target level. But what else can they do?
They cannot reduce rates any further to support growth, but neither dare they raise them to fight inflation for fear of inducing a recession. The Pound indeed looks beleaguered.
In the Euro zone, the ECB has decided to leave the Euro zone’s fiscal crisis to the politicians and focus instead on controlling inflation, which at 2.8% is also above target. The ECB’s response has been to tighten policy, with further hikes expected.
Unlike the UK economy, the Euro zone economy is being pulled along by a dynamic German expansion, so although several weaker peripheral economies are still struggling to grow, the strength of the German economy is masking this.
In short the Pound is hobbled by a sluggish fragile recovery and impotent Central Bank. The Euro is strengthened by strong German and French growth and a Central Bank already taking action to control inflation. Widening interest rate differentials look like testing parity in Sterling Euro before too long.

For the complete and illustrated version of this and future Updates be sure to sign up at www.sevendaysahead.com