Divergent monetary policies a more powerful EUR driver than Greek risks

Euro has remained relatively resilient, despite a substantial deterioration of the situation in Greece. Although Grexit risks are negative for the Euro, data and divergence of monetary policies are more important drivers. Improving US data and diverging monetary policies to weaken the Euro by the year-end

Relative data surprises have recently started turning in favor of the US, but are still consistent with a stronger Euro. Short-term rate differentials would also justify EUR/USD well above current levels. 

"We project EUR/USD at parity by the end of the year, expecting the first Fed rate hike in September and low Eurozone inflation to keep the ECB's QE commitment strong. Greek risks, negative Bund net supply and light positioning also pose short-term EUR risks." says BofA Merrill Lynch in a research note.

The introduction of Greece capital controls and the 'No' vote in the referendum have weakened the Euro, but the impact was smaller than many investors may have expected. The Euro will weaken in response to Greek risks only if periphery rates and European equities sell-off substantially

"We still believe that Grexit will be negative for the Euro, although we don't necessarily expect a sharp adjustment." notes BofA Merrill Lynch

The dovish Fed and the not dovish-enough ECB have been more important EUR/USD drivers. This does not necessarily suggest that the Euro will not weaken during Grexit. Indeed, the ECB will be more likely to ease policies further in response to Grexit, than the Fed to postpone its first rate hike. 

EUR/USD currently trades at 1.1025, down around a third of a percent, having topped $1.11 in the Asian trade. Focus will be on proposals expected from Athens for a deal to keep Greece and its banks financially afloat. A fall in U.S. yields following the release of minutes of the Federal Reserve's June meeting offered little hope to dollar bulls. The dollar index dipped as low as 96.123 in Asian trade.