On Thursday, April 10, the Bank of England and the European Central Bank will each announce their monetary policy decisions. The markets are betting that one will cut rates, and that the other will leave their rates steady, which may create interesting opportunities when trading the Euro and British Pound this week.
Discuss the Euro and British Pound with our DailyFX Analysts on our EUR/USD and GBP/USD Forum Threads.
Bank of England – Risks Tilted Toward Aggressive Fed-Style Rate Cuts
Rate Announcement: April 10, 2008 at 11:00 GMT
Bias: 25bp Cut, Small Chance of a 50bp Reduction
Conditions in the UK housing and credit markets have steadily gone from bad to worse, and are becoming eerily reminiscent of the beginning of the collapse of the US housing sector. While inflation is well above the Bank of England’s 2.0 percent target at 2.5 percent and upside risks remain given the resilience of commodity price gains, the Monetary Policy Committee has little room for maneuver. Indeed, when the US subprime debacle first became front-page news in August 2007, credit market conditions immediately started to tighten globally. At the time, many had thought the situation would be contained primarily to the US markets, but it became crystal clear that no one was safe when UK mortgage-lender Northern Rock requested emergency funding from the Bank of England in September as they struggled to maintain liquidity. The news triggered a bank-run by depositors, and Northern Rock was eventually nationalized by the central bank. Since then, the financial sector has not experienced another similar event, but this is likely because the Bank of England has made continuous efforts to boost liquidity in the money markets since December. .
Nevertheless, banks remain reluctant to lend. Nationwide and the Royal Bank of Scotland are among some of the banks that have raised mortgage rates in order to deter borrowing and limit exposure to that kind of debt. These restrictive conditions have only added pressure to the deterioration of the UK housing market in a high supply/low demand environment. During the month of March, HBOS house prices dropped 2.5 percent – the sharpest decline since 1992 – while mortgage approvals have dwindled down to 73,000 in February – the lowest since 1995 – from 120,000 in early 2007. This threatens to weigh on economic expansion, as consumers will be less likely to spend. In fact, during the fourth quarter, housing equity withdrawals fell to a nearly two-year low of 7.3 billion pounds, suggesting that consumers are no longer using their homes as a virtual ATM. While this may be a good thing from a practical standpoint, this does not bode well for spending growth in the UK services and retail sectors.
The minutes of the Bank of England’s March meeting showed that the MPC thought a “further tightening of credit conditions remained possible” and that “sentiment had deteriorated in the money markets and longer-term credit markets.” With these conditions coming to fruition and exerting significant downside risks for the UK economy as a whole, the Bank of England is expected to cut rates by 25bps to 5.00 percent. However, there is a risk that über-doves like David Blanchflower and John Gieve will vote for a 50bp reduction, though we will not know for sure until the release of the minutes from the MPC meeting later in the month. Regardless, the risks for the British pound remain greatly to the downside, especially against the US dollar as signs start to emerge that the Federal Reserve may not be as aggressive with their rate cuts in the near-term.
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European Central Bank – Still Hawkish, But No Hike.
Rate Announcement: April 10, 2008 at 11:45 GMT
Bias: No Change
[/B]The European Central Bank is expected to leave rates unchanged at 4.00 percent, but traders will be far more interested in the tone of ECB President Jean-Claude Trichet’s remarks, rather than the highly anticipated policy statement. Throughout the first quarter of 2008, Mr. Trichet has been unrepentantly hawkish, stressing the need to control prices first and foremost. Part of the reason for Mr. Trichet’s emphasis on inflation rather than growth comes from ECB’s mandate, which in contrast to the Federal Reserve, commands the Bank to maintain price stability rather than stimulate growth. However, the other reason for Mr. Trichet’s steadfast commitment to a restrictive monetary policy is due to the fact that for most of the first quarter, the Euro-zone has been largely insulated from the negative impact of the credit crunch that afflicted the US economy, essentially decoupling from the economic slowdown in the US.
Indeed, while the US economy has experienced job losses for the past three months in a row, Euro-zone labor markets continued to expand as the unemployment rate dropped to 7.1 percent - the lowest reading in this decade. The buoyant employment picture has allowed ECB officials to maintain its tight monetary policy without incurring too much political criticism. As we’ve noted in the past, “the ECB is unlikely to move on rates unless and until the employment situation in the 17 member region begins to deteriorate.” Yet, despite the relatively healthy labor market, the Euro-zone economy is beginning to show signs of weakness, most notably in the consumer sector. The latest retail spending report produced a shocking surprise to the downside as sales dropped 0.5 percent versus a 0.2 percent projected gain. Furthermore, the situation was even worse in the southern part of the region as Italian Retail PMI dropped to a recessionary-like reading of 36.4, marking its weakest performance since the survey began.
In short, the global slowdown in growth is beginning to afflict the Euro-zone economy as well, and the currency market will be watching carefully to see if Mr. Trichet acknowledges that fact. The ECB does not like to surprise the markets, preferring instead to prepare investors for any policy changes well in advance. Therefore, if Mr. Trichet chooses to de-emphasize price pressures and instead focuses on the possible downside risks to the Euro-zone economy, traders will interpret his words as a sign that the ECB’s monetary policy bias has turned from restrictive to neutral. In that case, with no future prospect of any additional rate hikes in the Euro-zone, traders are likely to sell the euro across the majors on a wave of profit taking. On the other hand, if the ECB remains stalwart in their focus on inflation, the currency could continue to be bid on the same de-coupling theme that has taken the unit to record highs against the dollar.
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 0.8000 level. According to Technical Strategist Jamie Saettele, a major correction is underway in the EURGBP. The rally from .6535 (January 2007 low) is in 5 waves, therefore a 3 wave decline is expected. The decline likely reaches at least .7430; which is the confluence of the former 4th wave and the 38.2% of .6535-.7983. One reason to have confidence in the ‘topping very soon’ scenario is that one can count a clear 5 waves from .7391. Near term resistance is at .7917 and .7932.
Written by Boris Schlossberg, Terri Belkas, and Jamie Saettele, Analysts for DailyFX.com