The forex markets were dominated by once piece of news, and one only yesterday, as the comments from Jean Claude Trichet were instantly pounced on, as evidence of an impending rate rise in Europe, as the ECB Governor presented a hawkish view of the European economy, and signalling that inflation would remain at the top of their agenda over the next few months. In his robust statement, he also made it clear to other member states, that they would need to implement further austerity measures in order to dampen demand, or run the risk of an interest rate rise sooner rather than later. All this comes against the backdrop of the ongoing and severe bond issues in Greece, Portugal, Ireland and Spain, and more recently potential problems in both Italy and Belgium, which seems to have been ignored in yesterday’s euphoria.

In his statement Trichet stated that inflationary pressures remained “short term”, and that the headline rate of inflation was expected to fall later in the year, but as a result “very close monitoring is warranted”. It was this comment that sent the euro spiralling higher, and climbing over 300 pips on the day against the US dollar, perversely ignoring the fact that the bond problems of peripheral member states remain the key issue for the time being. It was interesting to note that equity markets largely ignored the news, with both the Dow Jones and the FTSE 100 closing lower yesterday, clearly sending a strong signal that this was an over reaction to the news, and one that would normally have seen a strong euro pull equity markets higher, which was not the case. Indeed in a forthcoming article to be published this weekend, Paul Krugman, the Nobel winning economist writes that the strict Eurozone rules now being pursued by Jean Claude Trichet and others in Brussels, favours the strong nations such as France and Germany, with the smaller member states left to their own devices, which could see a mass exodus from the euro, coupled with widespread defaults amongst these as a result.

Inflation of course is nothing new, and in the last few months we have seen the problem beginning to surface in the Far East particularly, with South Korea, Thailand and China being forced to raise rates in order to control rising prices, particularly in food and commodities, whilst Western countries such as the US and Europe exhibit slower growth, with yesterday’s comments triggered by a jump in last month’s headline rate to 2.2%. This was the first time that the inflation figure has risen above the bank’s target of 2%, the same as for the UK, which in turn has seen inflation rise to 3.3% with some analysts now forecasting a rise to 4% and beyond. Indeed with oil now breaking higher and moving towards the $100 per barrel price level, this is likely to add further pressure to the UK government.

So what are we to make of yesterday’s strong move for the euro – is this a longer term trend, or simply a short term market reaction and likely to reverse just as quickly? My own view is simply this, that yesterday’s move was a stop hunting exercise by the forex market makers, who seized the opportunity to squeeze euro bears out of their positions in a rapid rise, triggering stops, a feature of this mornings price action once again. With deep stops set above the recent highs of the last few weeks, this is a classic move to shake traders out of their short positions, and as such we need to stay calm, hold our nerve, and wait for the inevitable reaction lower, which looks to have started already in early trading, with the EUR/USD pulling back from the high of 1.3457, and now trading lower at 1.3365.

The conclusion is simple – yesterday’s price action was market manipulation by the forex market makers to take out layered stops in the 1.3450 region and above, before taking the pair lower once again, clearly the case since equities failed to follow the euro higher. So expect to see the euro weaken once again over the next few days, particularly against the US dollar, and move back to retest the 200 day moving average in due course as the bearish momentum of the last few weeks is reinstated.