Week in FX Europe – Few Surprises, More Questions

Nowadays it’s in a central bank’s DNA to jawbone a currency lower. If it’s not Governor Glenn Stevens at the Reserve Bank of Australia, then it’s the European Central Bank’s (ECB) President Mario Draghi. There were no surprises yesterday from either the Bank of England (BoE) or ECB on the rate front, with both institutions holding firm on main lending rates.

With respect to the U.K., its strengthening economy means the BoE remains on course to be the first of the world’s major banks to tighten its monetary policy from historic low yields as early as this November — the majority of fixed-income dealers are pricing in a hike in the first quarter, 2015. The International Monetary Fund expects the U.K. to be the fastest-growing advanced economy this year, justifiably so after the U.K.’s second-quarter +3.2% annualized growth rate. Governor Mark Carney remains mindful of spare capacity in the U.K. labor market, in particular wage growth, despite unemployment rates tumbling. U.K. inflation remains a tad shy of the BoE’s +2% target at +1.9%.

BoE Forecasts Ahead

The BoE’s last two Monetary Policy Committee meeting minutes suggests that the decision as to whether or not to tighten is becoming more balanced — a shift by a few individuals. The BoE will publish its forecasts for growth and inflation next week. Hopefully, next Tuesday’s reports will give up fresh clues to the possible timing of the BoE’s first move.

The ECB, too, left its’ polices unchanged, while acknowledging ultra-low inflation and slowing economic prospects. Draghi continued to uphold his confidence that the ECB’s June measures (negative rates and more credit) would ultimately push prices and growth higher over the medium term.

In the press conference, the ECB chief pushed back against criticism that the bank is not doing enough by further detailing the targeted longer-term refinancing operation (TLTRO) program, asserting it will disburse up to €450B to €850B to the real economy. He also noted that eurozone fundamentals for a weaker FX rate were much better now. His efforts thus far to sink the EUR have been half-hearted at best. His currency-related comments are aiding the EUR bear to consider making an assault on last November’s low in the short term (€1.3295).

On Ukraine, Draghi warned the conflict had the real potential to negatively impact the eurozone, more so than anywhere else. In terms of quantitative easing (QE), the ECB’s Governing Council is unanimous about using non-standard tools, like QE, if and when needed. Despite his dovish tone, he and his fellow policymakers have faith in last June’s package of measures. The ECB does not want to fast-forward to QE. For that to happen, the eurozone economy needs to deteriorate much further and much quicker. But, will it be too late?

Draghi also explained away Italy’s dismal gross domestic product print to low private investment on the back of a lack of structural reforms in Italy. When it comes to Portugal’s Banco Espirito Santo — the government’s and authorities’ moves last week was swift and effective, thereby restricting the financial problem to one institution, and not affecting the Portuguese banking system or the country’s sovereign entity.

What to Expect Next Week

Central banks are done for a while, but the market will get to hear from Carney midweek. The BoE will publish its forecasts for growth and inflation and investors will be looking for clues on the timing for the U.K.’s first post-crisis rate hike. Aussie business confidence data will kick-start the week Down Under, while the German ZEW economic sentiment will open the European session. Ahead of U.S. consumer sentiment rounding out the week, the market gets a peek at U.S. consumer appetite from its retail sales data.

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