On Thursday, December 6, 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?
[B]By Terri Belkas, Currency Analyst, DailyFX.com, FXCM LLC
Published: December 5, 2007[/B]
A global credit crunch has rocked the markets since August when the US subprime lending fiasco first came to the forefront, though the issue had been simmering under the radar for quite sometime. As a result, major financial institutions have grappled with the effects of billion dollar write-downs on subprime-backed assets, which have taken a particularly large toll on the US. However, other markets have not been immune. In fact, European and UK interbank lending rates have recently hit multi-year highs while equity markets remain especially jittery and prone to declines. This has left central banks like the Bank of England and the European Central Bank uneasy, as the instability of the markets adds to mounting downside risks to growth. On the other hand, rocketing food and energy costs have threatened price stability as they push CPI figures in the UK and Euro-zone through the roof. On Thursday, December 6, the BoE and ECB 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?
[B] Bank of England – Risks Tilted Towards A Cut In The Near-Term, Watch For Surprise Policy Statement
Rate Announcement: December 6, 2007 at 12:00 GMT
Bias: No Change, But Chance of Rate Cut
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The minutes of the Bank of England’s November monetary policy meeting reflected a 7-2 vote to keep rates steady at 5.75 percent, with members Blanchflower and Gieve voting for a cut amidst fears that money markets may become tighter as the credit crunch persists. The report suggested that the central bank was indeed becoming more dovish compared to October, when the vote was 8-1. However, comments that a cut could be misinterpreted and concerns regarding upside inflation risks from higher oil and commodity prices signals that the monetary policy committee would prefer to wait until price pressures subside. Nevertheless, 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 in the first quarter of 2008. Has anything changed since the last BOE meeting that indicates the potential for an actual rate cut in December?
Yes. On the economic front, retail sales for the month of October unexpectedly fell 0.1 percent from the month prior while more current GfK consumer confidence figures eased to -10 from -8, indicating that sentiment continues to wane and will likely drag spending figures lower as well. Meanwhile, housing market data has eroded quite a bit, with Nationwide house prices down 0.8 percent during November – the sharpest drop in 12 years – while mortgage approvals slumped to a nearly three-year low of 88,000 in October from 100,000. Meanwhile, a spike in short-term interbank lending rates (LIBOR) in recent days to multi-year highs signals that tight credit market conditions are only getting worse. On the other hand, October CPI readings were stronger than expected at an annual rate of 2.1 percent, which is above the BOE’s 2.0 percent ceiling. These inflation readings warrant attention, as record higher oil prices above $98/bbl in November will likely drive CPI reports for the same period booming as well. Nevertheless, the BOE did forecast a pick up in price pressures in late 2007 before they would pull back in 2008, signaling that they may not be entirely uncomfortable with the inflation readings. As a result, dovish MPC members like John Gieve and David Blanchflower – who recently called for a rate cut to “get ahead of the curve” – may stand a good chance of garnering additional support for decrease in the benchmark lending rate. Whether there will be enough votes to take a majority remains to be seen, but the unexpected issue of a dovish policy statement following the meeting could be almost as bearish for the British Pound as an actual rate cut.
[B] European Central Bank – Still Hawkish, But No Hike.
Rate Announcement: December 6, 2007 at 12:45 GMT
Bias: No Change, But Chance of Rate Hike
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When it comes to discussing price stability, the European Central Bank has been one of the most hawkish central banks throughout the year. After the November policy meeting, ECB President Trichet continued to note upside inflation risks and proclaimed that “monetary policy stands ready to counter upside risks to price stability.” Meanwhile, Trichet touted the strength of the Euro-zone economy and was optimistic regarding GDP forecasts, as resilience in emerging markets is likely to offset the impact of a slowdown in the US. Nevertheless, “the ongoing reappraisal of risk in financial markets…led to continued uncertainty,” and supported the case for leaving rates steady. Will this very same “continued uncertainty” lead the ECB to leave rates unchanged again in December? 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 November CPI estimates of 3.0 percent, which is well above their 2.0 percent ceiling. Furthermore, the unemployment rate for the Euro-zone fell to a record low of 7.2 percent in October, which may help to support consumer sentiment and thus, spending, going forward. Also faring well was the manufacturing sector, with PMI improving to 52.8 from 51.5. However, just like the UK and the US, Euro-zone credit conditions are still extremely tight and financial markets remain easily spooked and prone to volatility. 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 January, 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.
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