Fundamental Forecast for Euro: Bearish

- Euro Zone Economic Confidence Hits Two-Year High
- German Labor Market Unexpectedly Improved in March

The Euro may resume its four-month down trend after the European Central Bank delivers their monetary policy announcement as the Greek debt crisis returns to the forefront against a backdrop of a still lackluster interest rate outlook.

The markets were apparently unconvinced by the European Union’s IMF-assisted scheme to bail out Greece should the debt-ridden southern European economy fail to finance its gaping fiscal shortfall in the markets. Indeed, last week’s auction of 12-year Greek bonds raised just 390 million euro, falling short of the 1 billion on offer. Other signs of instability were plentiful: the spread on Greek credit default swaps rose while the spread between the yields on Greece’s benchmark 10-year bonds and those of Germany (considered the euro region’s safest) widened, both to the highest in over a month. The market seems intent to test the EU’s resolve by forcing it to actually go through with a bailout, making the Euro’s performance contingent on how quickly policymakers step in. The sloppy approach to the situation so far also bodes ill for the single currency. Indeed, if the Euro Zone can’t muster a response to troubles in a small member state like Greece – just 2.6 percent of the currency bloc’s economy – this surely invites unfavorable expectations about the kind of havoc that could be caused if a country like Spain (11.8% of EZ GDP) or even Italy (17% of EZ GDP) meet a similar fate.

Meanwhile, the inflation outlook remains lackluster despite last week’s unexpectedly large increase in flash consumer price estimates that hinted prices rose at an annual pace of 1.5 percent in March, the fastest in 15 months. Indeed, the reading remains comfortably below the ECB’s target 2 percent level with much of the recent increase owing to the rebound in oil prices filtering through into the headline figure, hinting that underlying core inflation is even more subdued. On balance, this means the ECB is likely in no rush to be raise interest rates, with the bank president Jean-Claude Trichet’s post-announcement press conference likely to stay firmly focused on Greece-related issues.

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