Australia Holds Rates at 3% But Says Deflation May Prompt Future Easing (Euro Open)

The Reserve Bank of Australia kept interest rates unchanged at 3.00% but said the prospect of medium-term deflation could require further rate cuts. Swiss Gross Domestic Product data headlines a busy economic calendar on tap for European trading hours.

[U][B]Key Overnight Developments[/B][/U]

[B]• Australian Current Account Gap Smaller Than Expected on Imports Drop
• RBA Keeps Rates Unchanged at 3%, Says Deflation May Prompt Future Cuts[/B]

[U][B]Critical Levels[/B][/U]

The [B]Euro[/B] traded sideways in the overnight session, oscillating around the 1.4160 level. The [B]British Pound[/B] followed suit, with prices confined to a narrow band 60-pip band above 1.64.

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[U][B]Asia Session Highlights[/B][/U]

Australia’s [B]Current Account Balance[/B] deficit narrowed more than economists expected in the first quarter, showing a shortfall of just –A$4.6 billion versus expectations of a –A$5.4 billion result. The improvement came as the drop in Australians’ demand for foreign-made goods outpaced sagging outbound shipments. Imports fell -9.2% from the three months to December 2008, while exports declined -7.5% during the same period. On balance, external trade added 2.2% to overall economic growth in the three months to March. The Reserve Bank of Australia has argued that “signs of stabilization” in global growth (and particularly in China, a key trading partner) will help the larger antipode weather the current crisis better than most other industrialized economies. However, Westpac Banking Corp chief economist Bill Evans expressed skepticism about whether continued improvement in trading terms is sustainable, saying the deficit will likely expand in the second quarter as large declines in coal and iron ore prices weigh on export volume measures.

The [B]Reserve Bank of Australia[/B] kept interest rates unchanged at 3.00%, as expected. RBA Governor Glenn Stevens sounded cautiously optimistic, saying the evidence suggested the global economy was “stabilizing” as after most countries committed to aggressive stimulus measures. Stevens suggested that signs of recovery were clearest in China and some other emerging market countries. However, the RBA chief warned that global financial markets remain fragile and credit remains tight. Most significantly, Stevens said that although “monetary policy has been eased significantly…the prospect of inflation declining over the medium term suggests that scope remains for some further [interest rate cuts]”.

[U][B]Euro Session: What to Expect[/B][/U]

Switzerland’s [B]Gross Domestic Product[/B] report is expected to show the economy shrank -1.5% in the first quarter, the largest drop in at least three decades. The most recent comparable result dates back to the first quarter of 1991 when the economy shed -1.4%. Separately, the [B]SVME-Purchasing Managers[/B] Index is expected to show that manufacturing shrank for the eighth consecutive month in May, albeit at a slower pace than in April. On balance, the ability of these releases to meaningfully weigh on the [B]Swiss Franc[/B] seems limited: Switzerland’s troubles are largely a factor of overall weakness in global demand and the surge in risk appetite across financial markets since early March suggests that traders have long since priced in a dismal outcome for the first three months of 2009 and are looking ahead to a broad-based rebound later in the year.

Turning to the UK, May’s housing data is set to show a bit of an improvement from the previous month: [B]Mortgage Approvals[/B] are set to rise by 41K, the most in over a year, while [B]Construction PMI[/B] is likely to tick up to 39.5 from 38.1 in the previous month. Importantly, the news is only relatively encouraging: results in line with expectations would still see mortgage approvals down -25.6% from a year earlier while a reading below the 50 “boom-bust” level for the PMI metric means the construction sector is still shrinking, albeit at a slower pace. With that in mind, the data does not amount to a significant departure from the economic outlook already priced into the [B]British Pound[/B] exchange rate, suggesting sterling is likely to look past the releases to continue taking cues from trends in risk appetite. Indeed, short-term studies show a trade-weighted average of the Pound’s value against top counterparts is now over 85% correlated with the MSCI World Stock Index.

Finally, the [B]Euro Zone Unemployment Rate[/B] is set to rise to 9.1% in April, the highest in nearly 4 years. A survey of economists conducted by Bloomberg suggests unemployment will surpass 10% by the end of this year and continue higher through 2010. Mounting job losses will trim disposable incomes and weigh on consumption, the largest component of total economic output. Indeed, GDP growth in the currency bloc is expected to substantially under-perform that of the US and the UK heading into the first quarter of next year, suggesting the ECB is likely to lag behind the Fed and the BOE in raising interest rates, amounting to a bearish bias for EURUSD and EURGBP in the medium- to long-term outlook.

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