The Euro pared the overnight decline to 1.4269 to hold within the previous day’s range, and the single-currency may continue to regain its footing during the North American trade as European policy makers talk down fears surrounding the sovereign debt crisis.

Talking Points

British Pound: BoE To Maintain Dovish Tone Euro: ECB Talks Down Risk For Contagion U.S. Dollar: Wholesale Inventories on Tap

The Euro pared the overnight decline to 1.4269 to hold within the previous day’s range, and the single-currency may continue to regain its footing during the North American trade as European policy makers talk down fears surrounding the sovereign debt crisis. European Central Bank board member Ewald Nowotny said Greece may get an extension to pay back the EUR 110B bailout package during a radio interview, but noted that the current indications suggest the government will not be able to ‘refinance itself via the market next year’ as the scale of the debt crisis appears to have been underestimated. At the same time, Governing Council member Lorenzo Bini Smaghi said it would be “wrong” to restructure Greece’s debt while speaking in Florence, and warned that the aftermath would have a “dramatic” effect on the euro if the country chooses to go down that path.

As the risk for contagion intensifies, the ECB may have little choice but to delay its exit strategy further, and we may see central bank President Jean-Claude Trichet continue to soften his hawkish tone for monetary policy as higher borrowing costs exacerbates the ongoing turmoil within the European periphery. Nevertheless, market participants continue to see higher borrowing costs in Europe, with investors pricing the benchmark interest rate to increase by another 75bp over the next 12-months according to Credit Suisse overnight index swaps, and speculation for further monetary tightening should help to prop up the single-currency as the ECB maintains its one and only mandate to ensure price stability. In turn, the EUR/USD may continue to consolidate in the days ahead, but the euro-dollar could be in the process of carving out a head-and-shoulders top as the pair struggles to push back above the 78.6% Fibonacci retracement from the 2009 high to the 2010 low around 1.4430-50.

The British Pound managed to maintain the upward trend from earlier this year as the exchange rate bounced back from a low of 1.6325, but the sterling may face additional selling pressures over the next 24-hours of trading as we are likely to see the Bank of England maintain a dovish tone in its quarterly inflation report. As the economic recovery in the U.K. cools, the central bank may lower its forecast for growth and inflation, and the MPC may look to preserve its wait-and-see approach for most of 2011 as it aims to balance the risks for the region. As the GBP/USD appears to be carving out a right-shoulder around 1.6420-30, the technical development suggests the pair will ultimately breakout of the upward trend in May, and the pair could fall all the way back to 1.6000 should it struggle to hold above the 23.6% Fib from the 2009 low to high around 1.6200-20.

U.S. dollar price action was largely mixed on Tuesday, but the greenback may come under pressure during the North American trade as the rebound in risk appetite gathers pace. As equity futures foreshadow a higher open for the U.S. market, currency traders may diversify away from the dollar, but fears surrounding the global economy may continue to drive demands for reserve currency as risk sentiment dictates price action in the foreign exchange market. In turn, the DJ-FXCM dollar index may regain its footing going into the middle of the week, and the gauge may make another run at 9600 as investor confidence remains battered.

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To discuss this report contact David Song, Currency Analyst: dsong@dailyfx.com