• IMF Says Eurozone In ‘Critical Danger’
• ‘ECB should launch QE’
• Merkel Says ‘Boo’ To The Euro

Yesterday provided forex traders and everyone else with yet more signs of concern in the bond markets, where Spanish 10-year yields have climbed back to 6.94 percent, rising 11 basis points from 6.83 percent overnight. The latest touch paper appears to have been lit by remarks from Germany's FinMin Schäuble about how Spain remains ultimately liable for the bailout of its banking sector. Investors appear to be losing faith in Spain... again (while Italian 10-year yields are only slightly higher, at 6.06 percent). The overall trend was still for a weaker single currency given the concerns above, and growing scepticism that Spain will ultimately be unable to avoid a full-scale bailout. As Citi strategist Andrew Cox said in a note: "We suspect that continued signs of economic malaise in Europe and stress in European fixed income markets will keep the single currency under pressure over the medium term."

Yesterday’s truly major blow, however, came via a proclamation from the International Monetary Fund that the single currency bloc is in "critical" danger, and the European Central Bank should play a bigger role in fighting the debt crisis through more rate cuts, QE and further liquidity provision. Despite major policy actions, “...financial markets in parts of the region remain under acute stress, raising questions about the viability of the monetary union itself," said the Fund, adding: "The ECB can provide further defences against an escalation of the crisis. And to further strengthen its financial markets role, the ECB could also be given explicit responsibility for financial stability and full lender-of-last-resort functions, thereby eliminating bank-sovereign linkages present in the current Emergency Liquidity Assistance scheme."

The IMF also said the ECB could further lower borrowing costs, which are currently at a record low of 0.75 percent, because the economy was weak and inflation risks small. The bank could try quantitative easing (QE) with "sizable" sovereign bond purchases, possibly preannounced over a given period of time, the IMF said. The ECB could also embark on further sovereign bond purchases of countries that are under market stress - its Securities Market Programme (SMP).

Euro Under The Hammer

Along with various other market easing suggestions, the IMF insist the priority for the euro zone was to create a banking union, which would entail a common euro zone bank supervisor, as well as a common deposit guarantee scheme and bank resolution fund. An early response to the Fund’s report came from Nicholas Spiro of Spiro Sovereign Strategy, who said it reads like a "nuts-and-bolts manual for crisis management". Spiro went on to say how although the IMF had produced a comprehensive report, “...its message is clear: the causes and symptoms of the euro zone crisis have yet to be meaningfully addressed and require credible short and longer-term measures to sever the links between banks and sovereigns and mitigate the effects of fiscal austerity. Half-rescues are not going to work and the risks of the crisis escalating further are significant.”

As if all that wasn’t enough to hammer the euro, the single currency was dealt a real whack thanks to German Chancellor Angela Merkel reportedly saying she could not even be sure the European project would work. Frau Merkel’s words really spooked investors already cautious about the outlook for the common currency. Although she later offered a modicum of comfort that she was optimistic the project would succeed, the damage was done and the single currency predictably sold off, falling against the USD, AUD, JPY and a whopping eleven-and-a-half-year low versus the SEK.

Sterling Powers Through 

Today should offer some respite for the hard-pressed euro. Live currency screens saw it recovered pretty well after its heavy fall early in the European session, and we could see it continue to move higher today, taking advantage of a quiet euro zone. According to Craig Erlam of Alpari UK, “the next target for the pair will be around 1.2363, followed by 1.24. If the pair moves lower though, it should find support from the trend line around 1.217.”

Sterling also rallied to close yesterday’s trading above the triangle. “This would suggest that we're going to see a move higher for the pound over the next week or so, towards June's highs of 1.5776,” opines Erlam, who concludes: “The next resistance level though should come around 1.5731. Before this though, we may see the pair test the support strength of the top of the triangle.”

Drew Hillier. Editor, ForexSpace.com