EUR/USD – Euro extends rally, market turmoil eases

The euro has put together a 3-day rally and is up again on Tuesday. In the European session, EUR/USD is trading quietly at 1.0756, up 0.30%.

Financial markets settle down

Let’s start with some good news. European stock markets have settled down and are in positive territory. The euro took a bath last Wednesday and plunged 1.47% as Credit Suisse shares tumbled, but the currency has battled back and recovered these losses. The emergency takeover of Credit Suisse by UBS and the joint announcement by six major central banks to boost liquidity have provided some reassurance to the markets that the banking system is not in danger of collapse.

That’s not to say that this nasty bank crisis is behind us. Investors are still trying to come to terms with the lightning collapse of three US banks and Credit Suisse, the second-largest bank in Switzerland, all in just 11 days. Another US bank, First Republic, received an emergency injection of $30 billion from some major US banks, but this may not prove to be enough, as depositors are estimated to have removed $89 billion and the bank’s shares are in freefall.

In light of the bank crisis, central banks will have to weigh their moves carefully and re-evaluate rate policy. The ECB didn’t flinch and delivered a 50-basis point move as promised. Had the ECB decided not to go ahead with the 50-bp hike, it risked losing credibility. As well, the ECB’s primary focus remains containing inflation. With eurozone inflation running at an 8.5% clip, the ECB needed another oversize rate hike.

Could the financial crisis turn out to be a blessing in disguise? Perhaps, according to ECB President Lagarde. On Monday, Lagarde told European lawmakers that market turmoil could dampen demand and “might actually do part of the work that would otherwise be done by monetary policy and interest rate hikes”. Lagarde reiterated that more rate hikes were needed to curb inflation, but didn’t make any commitments as to the pace of rate hikes, which makes sense, given that the current crisis is not over.

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