On Thursday, January 9, the Bank of England and the European Central Bank will each announce their monetary policy decisions. The markets are betting that both central banks will leave their rates steady, but the perceived bias of each bank is very different, which may create interesting opportunities when trading the Euro and British Pound this week. Furthermore, the varying biases leave open a very important question: if there is a policy change, who will hike and who will cut?
Discuss the Euro and British Pound with our DailyFX Analysts on our EUR/USD and GBP/USD Forum Threads.
Bank of England – Risks Tilted Towards A Cut In Q2, Q3
Rate Announcement: January 9, 2008 at 12:00 GMT
Bias: No Change, But Chance of Rate Cut
Make Sure You Stay on Top of Support and Resistance Levels After the Rate Decision in the British Pound Currency Room
The minutes of the Bank of England’s December monetary policy meeting surprisingly reflected a unanimous vote to cut rates by 25bp to 5.50 percent amidst fears that money markets may become tighter as the credit crunch persists. The report suggested that the central bank was indeed far more concerned about the health of the financial markets and its potential negative impact on economic growth. However, the monetary policy committee signaled some hesitance to cut rates further, as they noted that this was a “preemptive” move and that a larger rate cut would “fuel inflation risks.” Furthermore, traders should keep the most recent BOE Quarterly Inflation Report in mind, as the bank’s forecasts saw inflation calming in 2008, assuming at least one rate cut by the first quarter of 2008, which we saw enacted last month. Futures are pricing in a 60 percent chance of a 25bp cut, but has anything changed since the last BOE meeting that indicates the potential for another rate cut in January?
Yes. Housing data has steadily deteriorated with the most recent reading from Nationwide Building Society showing prices falling for a second consecutive month in December, while consumer confidence and spending have waned. Meanwhile, both headline and core CPI were softer than expected in November at 2.1 percent and 1.4 percent, respectively, which leaves the BOE far more leeway to make monetary policy more accommodative, especially as inflation outlooks project easing price pressures. In fact, BOE MPC member Timothy Besley issued a research paper in December that found that interest-rate decisions tend to reflect inflation forecasts, which helps to explain why 9 out of 50 economists polled by Bloomberg News currently believe the central bank will cut rates by 25bp on Thursday. However, the majority believe that they will leave rates on hold, as do we. Indeed, the BOE will likely prefer to take a gradual approach to rate cuts, so as to not fan any existing price pressures as oil continues to trade dangerously close to $100/bbl. Instead, the central bank may opt to wait out the first quarter to gauge how the credit markets, inflation, and growth figures fare in light of their December rate cut. The price action in the British pound pairs following the rate announcement should be interesting, as the currency has plunged against the US Dollar, the Euro, and even the Japanese Yen. If the BOE leaves rates unchanged as we expect the markets may judge that the sell-off in the British Pound is overdone, and as a result, the currency could actually gain.
European Central Bank – Still Hawkish, But No Hike.
Rate Announcement: January 9, 2008 at 12:45 GMT
Bias: No Change, But Chance of Rate Hike
Make Sure You Stay on Top of Support and Resistance Levels After the Rate Decision in theEuro Currency Room.
When it comes to discussing price stability, the European Central Bank has been one of the most hawkish central banks throughout 2007. After the December policy meeting, ECB President Jean-Claude Trichet continued to focus on “strong upward pressure” on inflation, as outlooks for 2008 were revised up to 2.0 percent - 3.0 percent from previous expectations of 1.5 percent - 2.5 percent, assuming no second-round effects of oil and food price gains, which Trichet noted as being “key.” On the other hand, the ECB remained concerned about the ongoing reappraisal of risk in the financial markets, which the bank will “monitor very closely.” This, along with issues surrounding protectionism and oil price gains put growth risks “mainly on the downside.” Nevertheless, Trichet noted that more data and analysis would be needed to fully assess the turmoil, as risk reappraisal is still evolving. Will this “assessment time” lead the ECB to leave rates unchanged again in January? That’s what the markets are counting on.
Currently, futures are pricing in no change in rates on Thursday, as price stability remains the primary concern of the ECB. This is rather unsurprising as their hawkish stance has been justified by December CPI results of 3.1 percent, which is well above their 2.0 percent ceiling. Furthermore, the unemployment rate for the Euro-zone held at a record low of 7.2 percent in November, which may fuel wage growth. However, some economic conditions have started to deteriorate according to Q4 reports. Euro-zone PMI for the manufacturing sector dropped as exports suffer while retail sales and services PMI were softer than expected on lackluster domestic demand. With consumer confidence falling to the weakest reading in nearly two years in December, household spending is unlikely to rebound significantly anytime soon. As a result, the markets are betting that the ECB will leave rates unchanged at 4.00 percent on Thursday, but the deal-breaker for Euro bulls is whether or not Trichet will remain hawkish in his subsequent policy statement: If the ECB President notes the phrase “strong vigilance,” traders may immediately start betting on a hike in February, as this has previously served as an excellent signal of impending policy action. On the other hand, if the policy statement is essentially a reprint of the report from the month prior, or the ECB focuses more on the downside risks to growth, the Euro could falter as the markets judge that Trichet’s monetary policy tightening cycle is done for good.
Will The Rate Decisions Help Derail The EURGBP Rally?
Technically, the massive rally we’ve seen in EURGBP may be nearing an end as the pair closes in on the 0.7550 level. According to Technical Strategist Jamie Saettele, the rally has extended in a larger wave 3 (within the 5 wave rally from .6535), and since the pair trades at an all-time high there is nothing to go on as far as chart resistance is concerned. The form of the advance indicates that the EURGBP is likely to consolidate before making a new high. A corrective 4th wave would follow and likely last a few months, taking the pair back towards .7100-.7200 before a rally to complete the entire rally from .6535 in wave 5.
Written By Terri Belkas, Currency Analyst, DailyFX.com
Contact Terri Belkas about this article at <[email protected]>