Forex: Euro May Rise as ECB Falls Short of Dovish Market Outlook

Talking Points:

British Pound May Edge Lower as BOE Rate Decision Amounts to a Non-Event
Euro Has Room to Rebound as ECB Falls Short of Markets’ Dovish Expectations
Australian Dollar Sold After Soft Jobs Data Weighs on RBA Rate Hike Outlook

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A monetary policy announcement from the Bank of England promises to be another non-event. Despite a handful of upside surprises on recent economic releases, the trend in overall news-flow has been disappointing relative to expectations since mid-August (according to data from Citigroup). This suggests the economy has evolved closer in line with the central bank’s outlook than that of the markets since the introduction of the current “forward guidance” policy framework.

Indeed, the British Pound rallied when the MPC introduced its unemployment and inflation “knockout” thresholds in the summer as traders bet they will be hit faster than officials predicted, forcing an early unwinding of stimulus. That means the onus to adjust given the last several months of data is on markets, not the BOE. As such, Mark Carney and company are likely to stay on course, which may a bit of downward pressure on Sterling as hopes for a bit of a firmer tone following this week’s upbeat PMI and Industrial Production readings dissipate.

The European Central Bank may generate more volatility as it too delivers its monthly rate decision. The Euro plunged amid swelling easing bets last week as a string of dismal economic data releases was punctuated by an unexpected drop below to 0.7 percent on the headline year-on-year CPI inflation gauge. Investors primed for a sharp lurch to the dovish side of the spectrum are likely to be disappointed however.

An outright interest rate cut would be essentially symbolic: benchmark EONIA and EURIBOR measures of EUR-based borrowing costs are already substantially below the ECB’s benchmark; bringing the policy rate lower would thus offer little in terms of concrete easing. Other options may include another round of LTROs, a direct lending scheme similar to the BOE’s FLS effort, or perhaps the setting of negative interest rates on capital held in the ECB’s deposit facility.

At last month’s press conference, ECB President Mario Draghi suggested that additional stimulus was at least partially contingent on the outcome of the central bank’s Asset Quality Review (AQR). With those results still pending, the central bank probably won’t jump into a new policy regime on the basis of still relatively limited evidence from economic data. Pre-committing to a particular stimulus toolkit before the necessity of its use is decided upon is likewise unlikely. That means the markets will be treated to another round of vague generalizations, which ought to disappoint the doves and stands to send the Euro higher.

The Australian Dollar underperformed in otherwise quiet overnight trade. The currency sank after October’s Employment report disappointed, showing the economy added a net 1.1k jobs compared from the previous month. Economists were calling for a 10k increase ahead of the release. Details of the report proved little-more encouraging than the headline figure. Full-time employment fell by 27.9k, marking the largest drawdown in 16 months, while the participation rate plunged to a 7-year low at 64.8 percent. The result weighed against bets on an RBA interest rate hike expectations, with traders now pricing in 15bps in tightening over the coming 12 months, compared with 22bps yesterday (according to Credit Suisse).

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