Repeat: Analysts: Glass Half Empty/Full Debate On Euro, Eurozone

NEW YORK (MNI) - Wednesday's debate about the fate of the eurozone and the euro centered around "the glass is half-full" or "the glass is half empty" arguments, with no easy answers.

On the plus side, recent steps taken by eurozone officials have managed to quell fears about a EMU breakup and allow peripheral spreads to narrow modestly.

On the minus side, market players are not yet convinced that the peripheral storm is completely over.

These conflicting views are reflected in the trading action being seen in the euro also, with the pair potentially poised to test $1.40 or higher, but at the same time showing signs of topping out.

"Market sentiment towards the eurozone has changed substantially in just a few weeks," noted Beat Siegenthaler, senior currency strategist at UBS, in a research note.

"The resulting rising expectations of a 'comprehensive solution,' together with hawkish Trichet comments have boosted the euro," he said.

UBS retains their three-month euro forecast of $1.25, which is based on the view that market players will likely be disappointed in their expectation for a eurozone solution to the peripheral crisis as well as their expectation that the European Central Bank will raise rates earlier than expected.

However, Siegenthaler warned global investors to "monitor eurozone developments for indications of a 'game changer.'"

If indeed there is a "suitable solution to the debt crisis, this could catapult the euro to substantially higher levels," he said.

In an alternate scenario to UBS's base case, the euro could rise toward $1.50, if "a eurozone fiscal union" were agreed upon and the ECB started to "become more hawkish at the same time," Siegenthaler said.

Dates to watch: The February 4 EU Summit, the March 14-15 Ecofin meetings and the March 24-25 EU Summit.

Regional elections in Germany (March 20 and March 27) means the latter date is more likely to see progress, he said.

German Chancellor Angela Merkel will not want to see the March elections "dominated by euro headlines," he said.

"Nevertheless, political pressure is not as strong as to paralyse the German government, particularly as Merkel's CDU/CSU party is enjoying the highest support in a year according to latest polls (37%) while the opposition SPD has dropped to just 20%," Siegenthaler added.

In addition to eurozone peripheral containment, the market is trying to get a grip on ECB monetary policy.

In comments made during a Bloomberg television interview Wednesday, ECB President Jean-Claude Trichet said that current policy rates are 'appropriate' and insisted that the central bank is never precommits to any rate decision.

At a different venue, ECB Executive Board member Juergen Stark stated that the ECB might be forced to tighten monetary policy, even if such action would make things difficult for some member countries.

The ECB has already withdrawn some of its non-standard liquidity measures and remaining measures will be rolled back in line with market conditions and will "by no means" be kept longer than the mandate of price stability would allow, he assured.

"We will continue to regularly examine the appropriateness of monetary policy and will act in the event of a changed assessment," he said.

"It is important to become aware of the risks of a monetary policy that is too expansive for too long," Stark warned, reiterating a comment he has made several times in the past.

Stark also echoed comments made by other governing council members in recent weeks, noting rising price pressures, mainly as a result of commodity price hikes.

Due to commodity price increases, "inflation rates should still move at around 2%, or somewhat above that -- evidence of at least short-term upward pressure on total inflation," he said.

In remarks that could be deemed hawkish, Stark noted that, "the development of industrial producer prices and surveys indicate that inflationary pressure within the production chain is rising."

On the FX front, the euro was showing signs of sluggishness after a remarkable recovery from what could be described as its "deathbed."

A bit over two-weeks ago, on January 10, the euro was testing lows around $1.2871 and the market was preparing for a retest of August 2010 lows near $1.2584 or even the June 2010 trough of $1.1875.

Successful peripheral auctions, changing ECB expectations, extended euro short positions, and overall eurozone crisis fears being allayed all contributed to the fast-paced 6.6% run-up in the euro seen since mid January.

The euro was trading at $1.3706 Wednesday afternoon, down from the new two-month high of $1.3721 posted overnight and up from the day's low around $1.3645, seen in U.S. action.

The pair rose back over $1.3700 in the wake of the Federal Reserve's as-expected decision, but struggled to maintain a toe-hold above that level.

"The euro's stubbornly bid," said John McCarthy, director of foreign exchange at ING Capital Markets.

The euro has risen sharply, not just against the dollar, but also against other currencies, he said.

The rally seen thus far has been mostly the unwinds of "long embedded (euro) shorts," McCarthy said.

Currently, the market has its sight set on a test of $1.4000, although some players were troubled by the fact that the euro had a hard time holding over $1.3700 for a second day.

Wednesday the euro stalled around $1.3720, only a few points higher than Tuesday's peaks around $1.3710.

"We would need to get below $1.3580, $1.3560, before we see people starting to say that we have put in a second top," McCarthy said.