Forex markets: The euro has virtually reached our downside targets

The failed attempt to form a new government in Greece has compressed the euro to well below EUR/USD 1.30...  

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For the time being, we confirm our short-term downside target of 1.25, although fears of a Greece potentially exiting EMU could hold further downside. We have not revised sterling upwards, as the Inflation Report was unequivocally dovish and the BoE has singled out the euro are crisis as the main downside risk to UK growth.

EUR – The euro has virtually reached our downside targets, finally dropping below EUR/USD 1.3000: it has broken through the first technical target at 1.2827 and has almost reached the second (1.2624). This all happened this week, on the failed attempt to form a government in Greece. Now new elections have been called on 17 June, and the markets are starting to fear that Greece could exit EMU. The G8 summit will also take on the Greek crisis. If no encouraging developments emerge, the euro risks weakening further: downside in the EUR/USD 1.25 area, a level confirmed as our central 1m projection. However, in light of the latest developments on the Greek front, increased risk of Greece actually exiting EMU has heightened the risk of a deeper decline of the euro, to below 1.25. It is no easy task to quantify the downside tied to such an event, as there are no historical precedents. However, an initial hypothesis could be a depreciation into the 1.25-1.18 range. This is because on occasion of the “first” Greek crisis in the opening months of 2010, the exchange rate plunged from 1.35 to 1.18 (punctual low on 7 June 2010: 1.1877) in less than two months, between April and June. Considering that the starting point of the recent downswing is more or less in line, we do not think it unreasonable to expect a similar movement. As regards next week, PMI, IFO and confidence indices will be released, all referred to May. Should the data surprise positively (although expectations are for  the contrary) the euro’s current slide could temporarily stop, barring unfavourable developments on the crisis.

GBP – We have not revised upwards our projections for the pound as the Inflation Report revised downwards the UK economy’s growth projections, singling out the euro area crisis as the main downside risk. In his opening remarks, Governor Mervyn King let on that the BoE still hasn’t definitively closed the door on further quantitative easing. As a result, and given the decline of the EUR/USD, sterling corrected sharply, dropping from GBP/USD 1.61 to 1.56. Therefore, we have confirmed our 1m-3m projections, which allow for the possibility of a foray in the GBP/USD 1.55-1.50 range, mostly due in our view to (1) a drop of the euro below

EUR/USD 1.25, and/or (2) the announcement of a further expansion of the APF (next BoE meeting on 6-7 June). Next week, in the meantime, there may be room for a further weakening in the event of poor data releases (which include inflation, retail sales, the CBI survey of the industrial sector, and the second estimate of Q1 GDP) and BoE minutes (Wednesday) revealing a serious split on the APF.

JPY – The yen strengthened from USD/JPY 80 to 79 on mounting risk aversion tied to the Greek crisis. If sentiment does not improve, the exchange rate could attempt to reach USD/JPY 78. However, on Wednesday the BoJ will meet, and is ready to act to contain any further thrusts below USD/JPY 80.

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