Will the BoE, ECB Rate Decisions Leave Euro, Pound Poised to Rebound?

On Thursday, June 5, the Bank of England and the European Central Bank will each announce their monetary policy decisions. Expectations are for both banks to leave rates steady, but given the steep declines we’ve seen in the Euro and British pound recently, even decisions in line with expectations could lead the currencies to rally.

Bank of England – Risks Tilted Toward Additional Rate Cuts This Year
Rate Announcement: June 5, 2008 at 11:00 GMT
Bias: No Change

The Bank of England is expected to leave rates steady on Thursday at 5.00 percent – the lowest since December 2006 – for the second consecutive month. The rate decision will come at 7:00 EDT but since the Monetary Policy Committee is anticipated to leave rates unchanged, they are unlikely to issue a monetary policy statement which should leave the market’s reaction to the news somewhat muted. Nevertheless, given the sharp drop we’ve seen in the British pound in recent days, even an announcement in line with expectations could lead the currency to rebound somewhat.
What are the fundamental factors that the MPC will be taking into account? Inflation pressures in the UK have built up significantly on the back of rocketing commodity prices, as CPI jumped to an annualized pace of 3.0 percent in April. This is well above the BOE’s 2 percent target and dangerously close to the point at which BOE Governor Mervyn King would have to write a letter to Chancellor of the Exchequer Alistair Darling explaining how inflation had gotten so out of control, and how he plans on bringing it back to target. However, Mr. King said just about a month ago that the members of the MPC have “judged that it would not be sensible to raise interest rates significantly at this stage in order to induce a recession to try and keep inflation below 3 percent. As long as food and energy prices don’t continue to rise at the same rate, they can stay at these high levels, inflation would fall back.”
These expectations that inflation pressures will ease in coming months is only part of the reason why dovish MPC members like David Blanchflower continue to vote for aggressive rate cuts. The economy is gradually deteriorating, and conditions are likely to get worse. Indeed, in the past week we’ve seen signs that the UK housing, manufacturing, and services sectors are taking a heavy hit, as BOE mortgage approvals slumped to 58,000 in April – the lowest since record keeping began in 1999 – while the manufacturing purchasing managers’ index (PMI) for the UK tumbled to a reading of 50 from 51, indicating that growth in the sector has stalled. Finally, UK services PMI unexpectedly fell below 50 to 49.8 in May, signaling contraction in the sector.
However, perhaps the most daunting piece of news was an announcement from Bradford & Bingley, the UK’s largest lender to landlords. B&B appears to be in trouble financially, as they said they would sell shares at a 33 percent discount amidst deteriorating housing market conditions. The news led Fitch Ratings to cut its long-term default rating and placed the firm on “watch negative,” and while B&B’s Chairman has affirmed that the company remains “well capitalized,” it is obvious that the UK financial markets are far from stable. The BOE has already stated that there are significant risks associated with mortgage-backed securities in the UK, particularly commercial ones, and if property values continue to plummet as they have in the US, the global credit markets may be hit by yet another wave of severe tightening.
Given these significant downside risks for the UK economy as a whole, we can count on Mr. Blanchflower to vote for yet another 25bp cut. However, the majority of the Committee will probably be more concerned about upside inflation risks given the ascent of crude oil futures to record highs above $135/bbl just two weeks ago. We will not know the exact vote count for sure until the release of the minutes from this MPC meeting later in the month. As a result, the British pound could actually rally if the BOE leaves rates unchanged in line with expectations, especially as the currency has tumbled ahead of the meeting amidst week economic data.
GBP/USD From A Technical Perspective…


Ahead of the Bank of England’s MPC meeting, the GBPUSD has broken to multi-day lows, and according to Technical Strategist Jamie Saettele, the larger bullish bias is intact as long as price is above 1.9362. Today’s low (1.9525) is at the confluence of the 61.8% of 1.9362-1.9850 / former resisting trendline (now support). As long as 1.9362 is intact, the GBPUSD is expected to exceed 1.9850 and reach resistance from daily highs just shy of 2.0250. While no action is expected by the BOE, the simple lack of a rate cut could be enough to spark buying of GBP/USD.

European Central Bank – Still Hawkish, But No Hike.
Rate Announcement: June 5, 2008 at 11:45 GMT
Bias: No Change

The European Central Bank is expected to leave rates unchanged at 4.00 percent, but as usual traders will pay keen attention to the content of ECB President Jean Claude Trichet’s remarks at the post announcement press conference. Thus far, Mr. Trichet has been consistently hawkish, focusing on price stability rather than growth in the 15 member union. Mr. Trichet has good reason to worry about inflation, as the latest CPI readings in the region reached their highest levels in a decade printing at 3.6 percent in May, which is well above the ECB’s 2 percent target. Fueled by skyrocketing energy prices and rising food costs, the Euro-zone economy is unlikely to see any meaningful relief in inflationary pressures until oil prices fall significantly from their record highs.
On the other hand, the region’s economy is clearly showing signs of deceleration in both growth and demand. Last week the economic news was peppered with a string of disappointments as retail sales in Germany contracted by a whopping 1.7 percent versus projections of a 0.5 percent gain. Meanwhile, German unemployment actually increased for the first time in two years by 4,000 versus an expected decline of 25,000. In fact, the health of the labor market may prove to be the key to the future direction of ECB policy. Over the past few months, the region’s central bankers have enjoyed political immunity as the employment environment remained constructive. However, should May’s disappointing results prove to be the start of a new and unwelcome trend of job contraction, the ECB will no doubt feel the pressure to moderate its rhetoric and consider easing its monetary policy.
For the time being, however, the ECB is unlikely to deviate from their uncompromisingly hawkish stance. As Mr. Trichet himself noted just the other day, “We are the only central bank which is actively contributing to a major structural transformation of its own economy…We are called upon to extend progressively the euro area across the European Union as a whole…We know also that price stability is a prerequisite for financial stability, a very important objective at the current juncture.” Given those comments, the press conference on Thursday should produce no surprises for the market, though a bid tone could emerge on the ever-hawkish tone. However, should Mr. Trichet so much as acknowledge the growing evidence of a slowdown in the region’s economy, the euro may see some selling pressure, as traders will interpret Mr. Trichet’s comments as a sign that the ECB may be preparing for a change of course later in the year.
EUR/USD From A Technical Perspective…


Like GBPUSD, the EURUSD has broken to multi-day lows but the larger bullish bias is valid as long as price is above 1.5283. The decline from 1.5817 is labeled as a W-X-Y (complex) correction. The minimum bullish objective is one pip above 1.5817. Even if a larger more complex correction is unfolding from 1.6018 (such as a flat or a triangle), price is still expected to exceed 1.5817. Commentary by ECB President Trichet tends to spark volatility, and if his speech is sufficiently bullish, EUR/USD could easily surge higher in line with Technical Strategist Jamie Saettele’s Elliott Wave scenario.


Written Terri Belkas, Boris Schlossberg, and Jamie Saettele, Analysts for DailyFX.com
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