IFO Support Euro

Aside from the rising stock markets and the return of risk appetite the euro received a major boost from better than expected IFO numbers which printed at 103.4 versus 102.3. As we noted on Thursday, “Tonight’s IFO results put an end to any notion of a near term rate cut from Mr. Trichet and company. For the time being the region’s economy continues to expand at a moderate pace allowing ECB authorities to maintain their hawkish posture.”

That hawkish posture may soon change however if consumer sentiment in the region does not improve. The GFK polling of German consumers recorded its lowest reading in two years while in Italy Retail Sales actually contracted -0.3% on a month over month basis. The negative effects of the global credit crunch are slowly seeping into the real economy in the Euro-zone and should turbulence persist, consumer demand may weaken significantly, undermining ECB’s hawkish outlook. For now however, European monetary authorities continue to err on the side of price stability maintaining a restrictive policy.

Next week, the trade in the EURUSD will be driven almost exclusively by US event risk as FOMC and NFPs loom large on the horizon. In addition, equity market turbulence may still be a factor leaving the pair very vulnerable to more seesaw price action. In the near term the dollar may gain next week if the Fed cuts only 25bp or if risk aversion comes back to the market. But, in the long term the euro – which for the first time since 2002 week pays more interest than the dollar – continues to have the upper hand.