Euro steady on expectations of central bank action

The euro hovered below three-week highs against the dollar on Friday, holding steady on expectations that global central banks will step in to counter any adverse fallout from Sunday’s election in Greece.  G20 officials told Reuters that central banks from major economies stand ready to take steps to stabilize financial markets by providing liquidity and preventing a credit squeeze if the Greek election result roils markets. A coordinated action is likely to support risk appetite and provide relief to the euro although any bounce could prove temporary given Spain’s elevated borrowing costs and the risk of contagion to Italy, the euro zone’s third largest economy. The dollar was also under pressure on expectations the U.S. Federal Reserve may resort to further monetary easing after labour market data disappointed and consumer prices fell in May. The euro dipped 0.1 percent on the day to $1.2619, still within sight of Monday’s three-week high of $1.2672, struck after a 100 billion euro aid package for Spanish banks was agreed at the weekend. The dollar index fell to a three-week low of 81.703 against a basket of currencies. Much of how the euro will trade in the near term depends on the outcome of the Greek election on Sunday. Traders cited offers to sell above $1.2660 up to $1.2670 while option expiries were cited at $1.2600. “Investors will be reluctant to hold any meaningful positions either way going into the weekend,” said Ankita Dudani, G10 currency strategist at RBS. “The euro has come back from highs around $1.2650 and the only reason it will hold above $1.2500 is because of the extreme bearish positions and hopes of coordinated central bank action.” Hopes for more policy steps by major central banks were heightened after the UK government and the Bank of England unveiled a 100 billion pound ($155 billion) funding scheme for banks to boost credit on Thursday. Traders said the euro had scope to post short term gains if Greece’s pro-bailout parties manage to win a majority in Sunday’s election. In a scenario where the far-left anti-bailout parties win, the euro could drop towards near two-year lows of $1.2288 struck earlier this month. The uncertainty was reflected in the options market, where both one-week and one-month implied volatilities traded at elevated levels of 16.50 percent and 12.65 respectively, up from around 9.8 percent and 11.55 percent at the end of last week. Bearish positions In the past few weeks, speculators have added to very large bearish bets against the euro as many positioned for an eventual exit by Greece from the single currency and a possible spread of contagion to the bigger economies of Spain and Italy. Spanish and Italian bond yields eased on Friday, but still remained near levels considered unsustainable to borrow from capital markets. The deteriorating situation in the euro zone has galvanised policymakers to consider taking action ahead of a G20 summit next week. European Central Bank President Mario Draghi said on Friday the bank was ready to support euro zone banks, should it be required, while Bank of Japan Governor Masaaki Shirakawa said central banks can offer liquidity to calm markets in case the weekend Greek elections heighten tension. The dollar and euro came under pressure against the yen after the Bank of Japan announced no change in its monetary policy. Analysts said some investors may have positioned for a more dovish stance and were buying back the yen as a result. “There were a few expectations the BoJ may have pre-empted any further Fed easing by deciding to expand their asset purchasing, so there is a little bit of disappointment this morning,” said Michael Sneyd, FX strategist at BNP Paribas. The dollar fell 0.8 percent to 78.77 yen, while the euro dropped 1 percent on the day to 99.10 yen.