Currency watch: Euro struggles on as interest rates rise

Credit ratings agency Moody’s has come under strong criticism from the European Commission following the downgrade of Portugal’s debt to junk status.

The commission claims that Moody’s is guilty of making an assumption that Portugal will need a second bail-out. The concern is that this can lead to a self-fulfilling prophecy because it makes it harder for Portugal to borrow and keep afloat.

The euro weakened during yesterday’s trading as market participants awaited the outcome of negotiations on Greece’s second bail-out package.

The chairman of the Greek debt negotiations, Charles Dallara, was confident a solution could be reached that would satisfy the credit ratings agencies. After the first round of talks, held in Paris on Wednesday (6 July), he commented, “in spite of all the challenges, all the difficulties, the seeds of success are being planted.”

China, the world’s second largest economy, announced a 25 basis point rise in interest rates taking it to 6.56%. This is the fifth time in eight months that the People’s Bank of China has taken action in an effort to prevent the economy from overheating and curb inflation.

A slowdown in China has wider implications for the global economy and, although the decision was expected, it put riskier assets under pressure.

EU GDP posted a 0.8% rise quarter on quarter as expected and had little bearing on the euro’s fortunes. The same can be said for factory orders in Germany, which outperformed expectations but were shrugged off amid the Greek bail-out negotiations.

In the US, ISM non-manufacturing data showed that the services sector is still expanding but the rate of expansion is slowing. This did little to convince investors that the global economy is beginning to pick up.

As expected, the European Central Bank (ECB) yesterday (7 July) increased interest rates by 25 basis points taking them to 1.5%. At last month’s press conference, Jean-Claude Trichet, president of the ECB, used language such as “strong vigilance” in reference to EU inflation meaning the hike had already been priced in before today.

In yesterday’s press conference Trichet was asked if the rate rise would do more damage to the Eurozone’s peripheral economies, to which he replied: “The entire continent would benefit from maintaining price stability and confidence.

Jeremy Cook is chief economist at World First foreign exchange