June 18, 2018 / 11:44 AM / in 3 months

FOREX-Trade tensions keep FX markets on edge as euro steadies

* U.S.-China trade dispute escalation keeps euro pressured

* Yen, Swiss franc gain as investors seek safety

* Chinese yuan weakest since January

* Graphic: World FX rates in 2018 tmsnrt.rs/2egbfVh

By Tommy Wilkes

LONDON, June 18 (Reuters) - The euro stabilized on Monday after last week’s big losses but the threat of an escalating global trade war, a dispute in Germany’s governing coalition and a more dovish-than-expected ECB all weighed on the single currency.

After suffering its biggest drop in a month after the European Central Bank said it would keep rock-bottom interest rates on hold through the summer of 2019, the euro slipped again on Monday before recovering slightly to trade up 0.1 percent on the day at $1.1621, off its recent lows of $1.1543.

A decision by the United States on Friday to enact tariffs on $50 billion in Chinese goods was the latest salvo in a widening trade dispute between the world’s biggest economies, keeping broader markets on edge.

China’s official Xinhua news agency said Beijing would impose 25 percent tariffs on 659 U.S. products, ranging from soybeans and autos to seafood.

Currency reaction outside of specific highly trade-dependent Asian countries has been limited so far, but the worry for investors is that these tit-for-tat developments will eventually hurt global growth.

A broader trade conflict would be particularly troubling for Europe given President Donald Trump has signaled that he wants to slap tariffs on automobiles. European shares fell sharply on Monday.

Tensions with the governing coalition in Germany also weighed on the euro. Chancellor Angela Merkel’s Bavarian allies may defy her by implementing a plan to limit immigration at the German border and risk destabilizing her three-month-old coalition.

“The euro has been on the back foot since the ECB decision and today’s bounce does little to change the broader picture of the caution,” said Lefteris Farmakis, a macro strategist at UBS in London.

“The next thing that markets will be watching for is the flash PMIs (Purchasing Managers Index) later this week that will shed some light on the narrative that the euro zone economy is doing well. If they disappoint, expect more selling in euro/dollar.”

French, eurozone and German flash PMIs are due on Friday.

The dollar index traded flat at 94.756, below the 7-month peak touched on Friday after the U.S. Federal Reserve raised interest rates for the second time in 2018 last week and signaled its growing confidence on the economy.

Reflecting the growing concerns over the widening trade dispute, the Chinese yuan fell to its weakest since mid-January at 6.4595 yuan per dollar in the offshore market.

Analysts are divided about the impact of a trade battle on the greenback but many think it could boost the dollar if reduced trade raises inflation, forcing the Fed to hike rates more than what markets are currently expecting.

The Fed’s hawkish stance also stands in contrast to other major central banks like the ECB and Bank of Japan that are sticking with their 2008 financial crisis-era policy settings.

Stephen Gallo, currency strategist at BMO Capital Markets, said the recent announcements by such central banks showed the trade dispute was beginning to have an impact.

“Certainly, in this environment these central banks wouldn’t discourage a weaker currency. They have set the direction and the tone,” he said.

The yen strengthened slightly versus the dollar. It rose 0.1 percent to 110.48 yen as it is usually sought out by investors in times of market stress. The Swiss franc also rose.

Commodity-linked currencies briefly sagged on the back of sliding crude oil prices.

The Canadian dollar traded to as weak as C$1.3208 per dollar, close to Friday’s one-year low of C$1.3210, before recovering to C$1.3169.

The Australian dollar rose 0.1 percent to $0.7448 after plumbing a five-week low of $0.7426.

Additional reporting by Saikat Chatterjee Editing by Toby Chopra/Keith Weir

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