EUR

Euro hits new session lows after JC Trichet sounds less hawkish than the market had anticipated by stating that inflationary pressures remain contained over the medium term and expectations continued to be anchored. By adding that economic risks were still slightly tilted to downside, Trichet, has appeased the surge in interest rate hike expectations generated in last months press conference when he mentioned inflation for the first time in over 9 months. We expect the ECB to keep rates unchanged into year-end. Markets must distinguish between the central bank's acknowledging receding disinflation and jawboning for a tightening ahead.

The latest decline in EURGBP highlights the bearish multi-month outlook for the cross first communicated on Nov 14. The weakness reflects increasingly inflationary UK data and the hawkish shift in the MPC of the Bank of England. Intermittent EURGBP bounces have primarily resulted from positive euro news flow (decent bond auctions, hawkish ECB talk and receding peripheral bond spreads).

The story from the 2-year yield differentials also illustrates the GBP-positive outlook against euro. German 2-year govt yields minus their UK counterpart have fallen back below zero at -0.07%. The daily correlation between the GE-UK 2-year spread and EURGBP stands at 0.61. Considering markets pricing for at least one BoE rate hike before year-end, the fundamental dynamics appear to be in synch with the technical picture. Lower highs in EURGBP as well as December and January rebounds, which failed to regain the November highs should likely keep the bulls out of the fray. Expect a prelim target of 0.8350, followed by 0.8150 (Aug 2010).

http://chart.ly/6a9ptdf

Ashraf