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Thu 21 Jul 2011 10:21 AM

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Euro gains before summit, but markets still wary

US dollar stays softer weighed by uncertainty ahead of August 2 US debt ceiling deadline

Euro gains before summit, but markets still wary
BAILOUT PLAN The euro popped higher on news Germany and France had reached a joint position on a new bailout plan for Greece (Getty Images)

The euro edged up against the dollar on Thursday after Germany and France agreed on a joint position for bailing out Greece, stoking hopes for real progress at the coming European summit after an array of false starts.

Market players are looking to see if European leaders can thrash out a framework for keeping the raging debt crisis from engulfing more countries and threatening the banking system, with many worried that hopes for a resolution will once again be dashed.

But the euro has been propped up as the dollar suffers on worries that US lawmakers and the White House will be unable to cobble together a budget compromise and lift the debt ceiling as the August 2 deadline rapidly approaches.

The Australian dollar dipped after a survey of manufacturers' showed activity in China's manufacturing sector shrinking for the first time in a year in July, but the figures had little sustained impact after the latest GDP report showed overall growth remained robust.

All eyes were fixed on the European Union summit as investors look for a resolution to the uncertainty around Greece that has driven bond yields on the much larger economies of Italy and Spain sharply higher.

"Success will have to be judged by the extent to which the summit will provide a framework that will limit contagion risk to both the banking system and weaker peripherals, and repair the credibility deficit of the EU," said analysts at Deutsche Bank in a note to clients.

The euro popped higher on news German Chancellor Angela Merkel and French president Nicolas Sarkozy had reached a joint position late on Wednesday on a new bailout plan for Greece that will include participation of the banking sector.

The euro touched a high of $1.4275 before steadying at $1.4254, up 0.3 percent on the day and gaining about 1 percent so far this week.

Markets have been disappointed before, making the single currency vulnerable to a pull-back. Support is seen at $1.4133 with immediate resistance at around $1.4282, the euro's high on July 14, and the 100-day moving average at $1.4302.

Fears that Greece's crisis will spread to bigger economies in the region such as Italy and Spain have kept investors on edge. Earlier this week, yields on Italian and Spanish government bonds jumped above 6 percent before easing back.

"We expect little concrete in terms of measures to reduce contagion more broadly," said Jens Nordvig, global head of G10 FX strategy at Nomura in New York.

The nervousness over the euro zone debt crisis has been reflected in euro options, given the resilience of the single currency. Risk reversals show hedge funds and investors holding hefty put positions in case the euro were to take a hit.

Risk currencies have held up well given all the worries about the debt crisis in Europe, the threat of the United States temporarily defaulting on its benchmark bonds and the latest signal that China's red-hot economy losing some steam.

The Aussie dipped 0.3 percent to $1.0712 and hit a low of $1.0704, finding some near-term chart support after the China flash PMI confirmed talk of a sub-50 figure showing contraction.

The HSBC flash purchasing managers index for China helped dent the kiwi, which was flat on the day at $0.8564 after having earlier powered to a fresh 30-year peak at $0.8588.

The US dollar was broadly softer weighed by uncertainty ahead of the August 2 US debt ceiling deadline, with the threat of benchmark, AAA-rated Treasuries getting their credit rating cut in the event of a default.

The White House signalled it could support a short-term increase in the US borrowing limit for "a few days" if lawmakers agreed to a broad deficit reduction deal but needed more time to pass it.

Philadelphia Federal Reserve Bank president Charles Plosser told Reuters on Wednesday that the Fed is actively preparing for the possibility that the United States could default.

The dollar slipped to 78.70 yen, nearing a one week trough, from 79.31 on Wednesday and to 0.8197 Swiss francs.

The greenback remains 1.7 percent lower against the Swiss franc for the week and almost 12 percent for the year so far as investors have favoured the franc given the troubles plaguing the world's two major reserve currencies.

The dollar index slipped 0.2 percent to 74.680. DXY, threatening to break chart support at 74.54/53 - an upward trendline from the May lows as well as the base of the Ichimoku cloud.