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The European Central Bank is planned to hold an extraordinary meeting on Sunday at 17:00 GMT, to discuss and immediate action to buy Italian bonds and calm the markets. An agreement on wide action in the currently split ECB can boost EUR/USD at the wake of the new trading week.

A Sunday afternoon in mid-August isn’t the preferred time for business meetings, but these aren’t normal times. In addition to the ECB meeting, there are reports about G-7 and G-20 discussions about acting in the markets, about responding to the US downgrade by S&P.

On Thursday, Jean-Claude Trichet’s ECB decided to act in a limited way in the bond markets, by buying only Irish and Portuguese yields. This triggered a global sell off. On Friday, it became clear that the ECB, which has the tools to stop the debt crisis by buying bonds, lowering yields and stabilizing the markets, had set conditions to Italy: faster and bigger actions to cut the budget.

Berlusconi got the message and announced front loading of harsh measures with an aim to balance the budget by 2013. This helped the euro close higher, but Italian bond yields still closed at above 6%.

Now, the ball is in Trichet’s field, and in the meantime, the historic downgrade of the US by S&P is set to renew the global sell off.

So is Trichet willing to act?  The emergency meeting means that he is ready.

EUR/USD Reactions

An  announcement by the ECB before markets open is likely to provide EUR/USD with an initial boost.

But later, uncertainty is much higher. Trichet is reluctant on bond buying and  doesn’t have unanimous support: German  representatives  in the ECB opposed Thursday’s limited bond buying. They might force the ECB to make limited moves now.

There is a gap of around 10 hours between the opening of the forex markets in Sydney and Wellington, until bond markets open in Europe. When Italian bonds will begin trading, we will get to see what the ECB is doing, what the “bond vigilantes” are doing and whether other global forces are ready to act.

If the actions are limited, these gains can be erased. In the long run, if the actions are extreme and not  sterilized, this will turn into a quantitative easing / euro printing scheme that will weaken the euro.

In any case, these are extreme times: a downgrade of the US is unprecedented. So is the situation in which the world’s 8th largest economy, Italy, can run out of cash by September.

In these “interesting times”, volatility is high and caution is necessary.

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