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Incredibly wild night of action in FX markets as both euro and pound verticalzed in thin holiday trade to take out multiple option barriers and triggered a torrent of stops. Once the EUR/USD crossed the psychologically important 1.3000 level it invited massive inflows of speculative capital as momentum players, option sellers and wrong footed dollar bulls all scrambled for euros sending the pair higher by 70 points in a matter of seconds. The pound also rallied hard taking out the 1.9300 barriers as it made 20 month highs.

Having now reached these august levels the question facing the market is - what’s next? Although, much like a snowball rolling down a mountain, these momentum rallies can take a life of their own , we suspect that after some sober post holiday analysis the markets may conclude that this move is a bit overdone. With EUR/USD now above the 1.3000 level it will become progressively more difficult for EZ exporters to sustain their growth which has been the underlying foundation for the region’s economic recovery. Already producers worries are evident in tonight’s French production outlook which slipped to 14 from 17 expected. Unless EZ consumers increase their spending - and up to now they have shown very little inclination to do so, even with the motivation of higher VAT taxes next year - EZ growth could slow markedly into Q1 of 2007 putting a halt to any further rate hikes from ECB.

Meanwhile in UK, the economic news was also not supportive of this monstrous move in the pound as UK GDP printed slightly weaker at 2.7% versus 2.8% expected. More troubling for pound bulls was the sharp slowdown in private consumption which rose only 0.4% versus 0.6% expected. Given the fact that BoE’s recent rate hike decision was made with a surprisingly dovish 7-2 vote, further rate increases from UK central bank may not be forthcoming.

In the near term however, none of these economic considerations may matter as sheer momentum could easily overwhelm the fundamentals. In a typical irony for FX markets, volatility skyrocketed as a time when almost no one expected it to – during a holiday leaden week when US and Japanese traders were away from their desks. Once they return on Monday this one way market may finally begin to pause.

Click the Euro Pound At Monthly Highs header link above for more information about the forex market.

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