Fundamental Outlook for Euro This Week: Bearish

- Regional inflation stalled yet investor sentiment hits a three-year high
- European Community finance ministers looking for an economic recovery, government exit after G8
- Will EURUSD resume its declines? Get the technical perspective on the outlook

Are the signs of growth in the Euro Zone already so bright that the government can’t start removing is financial stimulus and the ECB start discussing rate hikes? Though they are retaining their sense of caution, the region’s finance ministers seem to be leaning this way; and even a slight lean from official can be translated into certainty by speculators. Looking out to the week ahead of us, there is plenty of economic fodder on the docket – and much of it is influential enough to spark volatility and alter timing on the eventual economic recovery – but the real fundamental theme will be in determining whether policy officials’ determination to facilitate a recovery is commendable or setting the economy up for another crisis should the rebound fall apart.

Though there are no specific events or speeches scheduled next week that can trigger a debate monetary policy, there will no doubt be commentary to speculate against. While the general consensus among European authority figures is more hawkish than the global average, there is still a notable divide between the European Central Bank and the Union’s politicians. Over the past few months, the ECB has taken a neutral turn and capped the benchmark lending rate at 1.00 percent. The greatest point of contention (both within the member ranks and outside) has been the covered bond purchasing program, which central bank President Jean Claude Trichet has said has been put on a ‘full stop.’ Language from the policy officials leaves the door open to loosening the monetary reins in the future should it be warranted; but debate over the next steps run high. In contrast, the collective governments present themselves as confident that positive growth is just around the bend. Recently, officials said the first signs of a ‘sustainable economic recovery’ are already visible. However, forecasts still point to a 4.0 percent contraction in GDP through 2009 and a 0.3 percent slump next year.

The more intense debate between Europe and the some other major economies is how much government support should be used to prop up a recovery and how long it should be kept in place. At the G8 meeting this past weekend, UK and US officials were adamant on focusing on the economic recovery and defer efforts to deflate budget deficits until the recovery is more tangible and global. However, French and German Finance Ministers were clearly more interested in rolling back government aid. Currently, deficits are expected to average 6 percent of GDP this year and government spending will total 5 percent of GDP through 2009 and 2010. If the global economy is indeed in experiencing a lasting resurgence, this approach will put the European area in a more stable financial position. On the other hand, if the recession is more deeply seated and financial troubles are still in the pipeline, they will find themselves removing the support beams on an already comparatively small cushion too early. The ECB has projected regional banks are looking at another $283 billion of write downs going forward (dwarfing numbers to this point) and the IMF projects much more. With worries of default in Eastern European countries and losses from banks expected to grow, there is reasonable concern that a financial crisis is brewing in this region. Each member of the Union has performed a stress test of their respective banking system, but officials not been forthcoming with the results and neither do they favor a look at the exposure and health of major, individual banks. Is this a bomb waiting to go off?

Outside of the grander fundamental themes, there are plenty of indicators to watch for volatility as market participants benchmark growth. The best, leading indicator for growth in the Euro Zone is the monthly PMI data. The preliminary service and factory numbers for June will be released on Tuesday. Aside from these, German business and consumers sentiment, Euro Zone trade figures, Community industrial orders and German inflation have all been known to move markets.

John Kicklighter a Currency Strategist at FXCM.