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Research Note: August 6 BOE and ECB Rate Decisions
Brian Dolan, Chief Currency Strategist
Jane Foley, UK Research Director
Summary Outlook: First and foremost, we think Thursday's central bank decisions (BOE due at 0700EDT/1100GMT; ECB at 0745EDT/1145GMT, press conference at 0830EDT/1230GMT) will likely be overshadowed by Friday's US NFP report and Thursday's US weekly jobless claims. As such, we think it will take some surprises to generate a meaningful reaction to either decision.
Bank of England: The reaction to the BOE announcement will hinge on the BOE's determination of whether to suspend, pause, or expand their program of asset purchases. If the BOE suspends asset purchases outright, GBP may see additional strength, though we think current Sterling strength (1.7000) reflects this expectation to a large degree. In our preferred scenario, should the BOE indicate they will pause at the completed GBP 125 bio, but keep the door open to resuming asset purchases if later warranted, GBP may see an initial gain followed by a pullback. Were the BOE to expand its asset purchases to the authorized maximum of GBP150 bio, GBP would most likely move directly lower.
European Central Bank: Any market reaction to the ECB decision will likely only emerge from ECB Pres. Trichet's press conference. There, we see two main surprise scenarios: 1) Trichet depicts a weaker than expected economic outlook, and reiterates that 1% is not necessarily a floor on rates or that a rate cut was discussed; and/or 2) Trichet announces additional 'enhanced credit support' measures, possibly including direct lending to firms via commercial paper purchases. Both of those scenarios are likely EUR negative, in our view. But our preferred scenario is for a relative non-event: Trichet indicates that the growth and inflation outlooks are broadly in line with ECB expectations; signs of stabilization continue to emerge; and credit conditions are improving, albeit slowly.
Trading Strategy: Our central trading view is that, barring any of the surprises noted above, risk sentiment should continue to be the main driver in FX. Here, we think the weekly US jobless claims numbers will exert a greater influence than either of the central bank decisions. A weekly claims number above 600K could sour risk appetites (typically leading to USD buying, cross-JPY selling), while a reading below 550K could embolden risk taking(usually USD negative, cross-JPY positive). Even so, given that the weekly claims data will not be included in Friday's NFP report, the reaction to them should be short-lived and we would look for currencies to ultimately consolidate further ahead of the NFP report.
Economic Analysis:
BOE: An improvement in UK mortgage lending coupled with survey data from the Nationwide suggesting three consecutive months of house price rises and the ability of consumer confidence to hold at its best level since April 2008 support the view that the BoE will announce no increase in its QE program following its policy meeting on Aug 6. The Bank announced on July 30 that it had completed its GBP 125 bln leg of its asset purchased program, involving gilts. It has been granted permission by the government to extend this by another GBP 25 bln and, given the possibility that the economy may yet take a turn for the worse it is unlikely that the Bank will rule out potentially fulfilling this quota in the months ahead. Of note is that the BoE announced on July 30 that it will begin on August 4 to buy short-term debt from companies. This appears to be addressing directly concerns that extra liquidity is still not moving from the banks to where it is really needed. This also signals that the BoE is steering its asset purchasing plan in a fresh direction. More on this could be heard on August 6. News that the QE program will be extended would weigh on sterling. Similarly, confirmation that the Bank will not immediately be extending QE could give sterling a fillip and push cable up to its range highs above 1.7000. In view of the pound's underlying fiscal concerns we would expect to see sellers above there with scope back towards the 1.66/67 area initially.
ECB: The ECB is not expected to change the value of it refi rate (1%) potentially well into 2010. Possibly more interesting will be any references to the outlook with respect to its ‘enhanced credit support' plan. Recent comments from the ECB's Papademos confirm that the ECB has committed itself to continuing with the fixed rate tender procedures for all the main and supplementary refi operations for at least beyond the end of 2009. This enables banks to borrow unlimited funds at 1%. The ECB will also continue with its relatively modest covered bond purchasing plan (EUR3.8 bln have been bought so far). There is some evidence that the ECB's policy are having an impact, 3 mth euribor has trended lower. However, ECB lending data are yet to show a significant improvement. Lending to companies and households continued to tighten in Q2 albeit is at a reduced rate than in Q1 suggesting that banks are yet to pass on the additional liquidity afforded to them from the ECB. Inflation forecasts may also worry the ECB. A European Commission survey suggests that consumers increasingly expect prices to fall in the year ahead. The German inflation rate fell to -0.6% y/y in June, though to date the ECB rhetoric has maintained that inflation is in line with its projections. Given the weak price data and still soft lending data some speculation is emerging that the ECB will consider additional credit support measures at the Aug policy meeting such as the purchasing of commercial paper. It is likely that the ECB policy meeting will have no significant impact on the EUR, however, any change in rhetoric by the ECB exposing increased concerns about deflation could undermine the EUR.
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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