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Research Note: Dec. 4 Bank of England and ECB Rate Decisions
Brian Dolan, Chief Currency Strategist
Summary Outlook: (December 3rd, 2008) We look for a 150 bp rate cut from the BOE from 3.00% to 1.50% (consensus is for only 100 bps) and 50 bps of easing from the ECB from 3.25% to 2.75% (consensus is for 50 bps). The risks to our view are that the BOE delivers less and the ECB surprises by delivering more easing. Overall, we are approaching the rate decisions from the view that markets will embrace more aggressive easing and penalize less accommodation. If the BOE/ECB cuts only match consensus expectations, we would anticipate disappointed markets and an increase in pessimism, as the central banks are seen to be 'fiddling while Rome burns,' likely prolonging and worsening the economic downturns. Larger than consensus rate cuts, on the other hand, will likely support sentiment and may inspire stock market gains.
Market Outlook: We think the market has largely priced-in the consensus expectations, but would still anticipate an initial bout of weakness for GBP and EUR immediately following the rate announcements. If they ease more aggressively than expected, the initial dip in each currency might be greater, but improve the prospects for a subsequent rebound. In particular, if the ECB only cuts by 50 bps, we would expect the EUR to come under more sustained pressure as traders react negatively to the slow pace of ECB easing. Stock market reactions will again prove to be the deciding factors for currencies' direction, so traders will need to monitor closely how UK and European bourses respond. Also, keep in mind that US weekly jobless claims (expected weak) are due out at 0830ET, and the USD will be in play ahead of Friday's Nov. NFP report. In light of this pending US data, we prefer to be a buyer of GBP/USD and EUR/USD on post-announcement weakness (selling USD) as outlined below.
Trading Strategy: We would caution that the rate announcements may be quickly superseded by stock markets movements or US weekly jobless claims and that the reactions below may be very brief. For that reason, our strategy outlined below makes use of standing orders.
GBP/USD: If the BOE cuts by only 100 bps, we would look to buy GBP/USD about 100 pips below pre-announcement levels, and use a 50-point trailing stop loss as protection. We would look to take profit at between 100-125 pips above pre-announcement levels. If the BOE cuts by 125-150 bps, we would look to buy GBP/USD 150 pips below pre-announcement level s, widen the trailing stop to 75 pips and look to take profit between 150-200 pips above pre-announcement levels.
EUR/USD: If the ECB cuts by only 50 bps, we would stand aside as markets may hurt the EUR on perceived ECB inaction. However, if the ECB cuts by more than 50 bps, we would look to buy a dip in EUR/USD between 100-125 pips below pre-announcement levels, using a 50-point trailing stop as protection. We would look to take profit between 50-100 pips above pre-announcement levels.
EUR/GBP: If the BOE cuts by more than 100 bps and the ECB only cuts by 50 bps, we would prefer to be sellers of EUR/GBP on strength. The 45 minute delay between the two announcements makes for a challenging trade set-up, but we would look to sell EUR/GBP about 30-40 pips above pre-BOE levels and use a 30-pip trailing stop as protection. We would look to take profit/exit immediately after an ECB 75 bp rate cut, or between 75-100 pips below pre-BOE levels if the ECB only cuts by 50 bps.
Disclaimer: The information and opinions in this report are for general information use only and are not intended as an offer or solicitation with respect to the purchase or sale of any currency. All opinions and information contained in this report are subject to change without notice. This report has been prepared without regard to the specific investment objectives, financial situation and needs of any particular recipient. While the information contained herein was obtained from sources believed to be reliable, author does not guarantee its accuracy or completeness, nor does author assume any liability for any direct, indirect or consequential loss that may result from the reliance by any person upon any such information or opinions.
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