In US trade, the euro soared as EU leaders surprised financial markets with a set of initiatives designed to bring stability to the European banking system.
Some of the more pertinent headlines announced included: EFSF funds for the Spanish bank recapitalisation process will not be senior to Spanish debt; the ECB will take over as common banking supervisor by December, and after doing so the ESM will be permitted to recapitalise banks directly; the EFSF and the ESM will have the ability to buy sovereign bonds in the secondary market, a long-term eurozone integration roadmap will be laid out in October; and the decisions taken during the summit will lay the groundwork for Eurobonds.
The activation of sovereign bond purchase and the implementation of the ECB in its intended supervisory role will be a long-term process and is still subject to many yet-to-be-finalised details; the market’s reaction to the news might therefore have been a bit over the top and slightly premature, and will most likely come far too late to prevent Spain's sovereign debt levels increasing substantially over the coming months.
Attention now turns to Thursday's ECB policy decision, where a majority of economists expect a 25 basis point (bp) cut to the cash despite only 8bps of easing is priced in. If a rate cut is forthcoming, we would expect to see further downward pressure on the euro. From around 12.45 pm (AEST) on Friday, the euro rallied strongly from around the 1.2450 level to close the US session at 1.2667. Upon resuming for Asian trade, the euro has drifted to be trading in the mid-1.2630 range.