What’s on my mind this week? The Euro. And why, even without rate cuts, it looks set for a fall.

Monsieur Trichet has been getting a pretty rough press recently. He’s been portrayed as the tough, uncompromising figurehead of the European Central Bank (ECB); the pantomime villain who in the face of slowing global growth has warned that European rates might need to rise, not fall.

Now, it really pains me to defend a Frenchman, but he’s in the right. He and his fellow members of the European Central Bank are only doing what it says on the tin. But they won’t stop the Euro from falling.

How many times does some seemingly innocent event or news lead to a disproportionate move in the market? This happened last week when the EURUSD rate dropped by 200 pips following the decision by the ECB not to change rates. This reaction seemed all the stranger given the wild rumours beforehand of a cut in rates, but let’s take a butchers behind the scenes and see if the Euro 2008 is already in time added on.

What It Says On The Tin
The world’s central banks are the guardians of price stability; their aim is to keep the inflation genie tightly corked inside the bottle. But some countries fall for the genie’s patter and allow it out for a while; others attempt to bury the bottle in concrete. For a rundown on the top three central banks (sorry Japan, but we’re talking European profile here) and what they’re about why not check out Loan Sharks In Expensive Suits.

But if you’re pressed for time here’s a quick look at their job descriptions for tackling inflation, ranked in order of flexibility:

The US Federal Reserve Bank has both a broad and unspecific job spec. Its remit is to promote effectively the goals of maximum employment, stable prices and moderate long-term interest rates, but with no specific inflation target.

Price stability for the Bank of England is defined by the Government’s inflation target of 2% plus or minus 1%. Straying outside the 1-3% band requires the Governor of the Bank to write an open letter to the Chancellor explaining what’s gone wrong and what the Bank proposes to do about it

The ECB has the most single-minded approach, aiming for an inflation rate of below, but close to, 2% over the medium term. This ‘one-sided target’ is criticised for being less flexible than the other central banks as the focus on inflation requires a bias towards higher interest rates.

Tricky For Trichet
The ECB’s job description shows their dilemma; they’re not paid to give a rat’s arse about a slowdown in growth, only a rise in prices. Sure, they can acknowledge the likelihood of a slowdown happening, and if it happens there’ll inevitably be calls for the return of Madame Guillotine. But, and it’s a massive ‘BUT’, really their hands are tied. Look at the neat little summary below; it shows the current levels of inflation, how that level compares to the target, and the current level of interest rates.

Clearly, the US has higher inflation, but its job spec allows it to juggle enough balls in the air to come up with the correct political solution (which is usually cutting rates). The UK has the highest interest rate and yet inflation doesn’t look too out of line. The problem is that inflation is expected to rise above the top of the range, but that’s covered separately in The Message Is Loud And Clear.

But European inflation is over 1% above target, at a 14-year high, and with the risk of moving higher. Bang on Monsieur, stick to your guns.

One Hell Of A Statement
Last week’s statement from the European Central Bank set pulses racing at a level normally reserved for the evening visit to Spearmint Rhino.

“Sacre Blue,” what had happened? Well, a couple of things that the untrained eye, or ear, might have missed. Firstly, Monsieur Trichet conceded that, “Uncertainty about the prospects for economic growth is unusually high,'’ which was a reversal from last month, when he said growth in emerging markets such as China and India would cushion the effect of a U.S. slowdown.

Secondly, and you’ll love the subtlety here, the decision to leave European interest rates unchanged was unanimous. The previous vote had only been by consensus. Significantly, this implied that there were no longer any members voting for a rate hike. The markets aren’t very good at ‘inbetweenies’. “If rates aren’t going up then they must be coming down,” was the thought process of the forex boys.

Now, in fairness, Trichet and a whole bunch of European cronies went to great lengths to point out that fighting inflation remained their priority. Furthermore, there had been no talk of cutting interest rates. But no one was listening.

What’s The Word On The Street?
So, US rates are lower than Europe’s with a greater certainty of falling further in the next month or so. Won’t that help the Euro? Looking at the difference in interest rates it ought to, but quite a few investors are thinking laterally. The thinking is that the US is already tackling the problem of slower growth head on. This will allow it to be the first to come out the other side with a smile of relief and a healthier economy. The ECB’s inflation-fixation will mean that rates in Europe stay too high for too long. This will knock the stuffing out of a group of economies already showing signs of slowing.

So How Am I Going To Trade This?
After the ECB’s statement the Euro dropped quicker than Britney’s sex appeal. Since then the price has pretty much returned to the pre-meeting levels in EURUSD, but not against Sterling.

Check out the EURUSD chart first. The Euro made a record high of $1.4967 back in November. Since then, two good rallies failed to make new highs. This has strengthened the street cred of $1.4967 as a level of resistance (If you need reminding, have a read of Support & Resistance Lines-practising & preaching). I’m not rushing to sell this one yet; the 21-day moving average is pointing up so it could have further to go. But I’m watching the mini-uptrend for signs of enthusiasm wearing thin.

Now I’m really watching EURGBP closely. There looks to be good support at £0.74 (I bought it close to there for a cheeky trade today), but the rallies aren’t coming to much and a break of support could see a drop down to the £0.7250 support. Resistance at £0.75 is already gaining strength and the down trend line will bring resistance below this level over the next week.

Investors only have to think back to 2003 when Man United won the premiership and Europe was last in recession. At that time the Euro was a whole lot lower, making it easier for exporters to contribute towards growth. We’re not there yet, but a European slowdown could see the currency become Eurotrash.