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The British Pound may see selling pressure with clues from the Bank of England seemingly hinting the central bank is preparing markets for more, not less, monetary stimulus. The Euro may slide if the European Central Bank's rhetoric doesn't validate rising rate hike bets, shifting traders' expectations.
Key Overnight Developments
• Japan's Current Account Narrows as Exports Fall Most Since January
• Australian Dollar Soars as Jobs Gain 40K, Unemployment Rate Falls
• Euro, British Pound Rise Against US Dollar Ahead of Rate Announcements
The Euro pushed higher in overnight trading, adding as much as 0.6% against the US Dollar. The British Pound was more subdued but still advanced against the greenback, testing as high as 1.6012. We remain short GBPUSD at 1.6617 and EURUSD at 1.4710.
Asia Session Highlights
Australia unexpectedly gained 40,600 jobs in September, sending the Unemployment Rate lower to 5.7% from 5.8% in the previous month, the first drop in five months. Even more encouraging, most of the gains came from a 35,400 increase in full-time positions. The Australian Dollar surged as the data crossed the wires with traders taking the outcome as validation of RBA Governor Glenn Stevens' promise to extend rate hikes after the central bank unexpectedly raised borrowing costs earlier this week, pushing to test above the 0.90 level against its US counterpart for the first time in over a year. Traders are now pricing in a 99% probability that the RBA will raise rates by another 0.25% next month and at least 1.75% over the coming year.
Looking ahead, it is important to note that fiscal stimulus has played a key role in the labor market's resilience after the government spent A$20 billion in cash handouts to consumers and committed A$22 billion to new infrastructure projects. Indeed, a report from the Organization for Economic Cooperation and Development (OECD) has said that Australia's unemployment rate would be as much as 1.9% higher next year without the government's intervention, equating to about 150-200K more in job losses. While Treasurer Wayne Swan has promised that fiscal stimulus will remain in place despite the central bank's move to reverse expansionary policy, opposition parties in the government have strongly argued that spending needs to be wound down to reduce the public deficit and are now launching an inquiry into the government's policies, with results due at the end of this month. The ruling Labor party does not have a voting majority in Parliament, and it remains to be seen what happens to Australia's employment situation if the opposition successfully cuts off the flow of public funds to the economy.
In Japan, the Current Account surplus narrowed for the third consecutive month, printing at 1171.2 billion yen in August versus 1265.6 billion yen in the previous month. Exports fell -7%, the most since January, outpacing a -4.5% decline imports. More of the same is likely in the months ahead as the Yen appreciates, making Japanese goods increasingly expensive for foreign buyers. Indeed, last week's Tankan survey of large manufacturers (who primarily cater to the overseas buyers) revealed firms plan to slash capital investment at the fastest rate in over a decade on expectations that sales will fall -10.5% through the 2009 fiscal year (12 months ending April 2010), more than doubling the drop in FY2008. The currency looks set to extend gains after a trade-weighted index of its value broke higher out of a range that had contained prices since early March late last month.
Euro Session: What to Expect
Interest rate announcements from the European Central Bank and the Bank of England headline the economic calendar in European hours. While both monetary authorities are expected to keep policies unchanged, the UK announcement presents a greater potential for volatility versus its continental counterpart.
BOE Governor Mervyn King has done everything in his power to project a dovish bias since the last rate decision, telling the House of Commons Treasury Committee that policymakers are considering cutting the interest rate they pay on bank deposits to encourage lending and talking down the currency with assertions rebalancing the UK economy was very necessary [and] the fall in the exchange rate that we have seen will be helpful to that process in an interview with The Journal. We had speculated ahead of the September 10 rate announcement that the bank was preparing the markets for a change in policy after the asset-buying scheme largely failed to affect lending to the real economy. Indeed, although King has said that the BOE was beginning to see its impact on the supply of broad money, the M4 measure of money stock grew at an annual pace of just 12.6% in August, the slowest in a year, while central bank's own data showed net lending shrank for the first time in at least 16 years in July. While a policy shift had not materialized at that point, the BOE has not let up on hinting that more, not less, monetary easing is ahead despite the recent uptick in leading economic indicators, creating the distinct possibility for a dovish surprise this time around.
Turning the ECB, traders are likely to pay little attention to the actual interest rate decision. In fact, the ECB benchmark (officially unchanged at 1% since May) has not been representative of actual lending rates for some time, with the average cost borrowing Euros overnight oscillating between 0.5 and 0.3 percent since June. Rather, traders will focus on bank President Jean-Claude Trichet's post-announcement press conference. Key economic data turned in mixed results in recent weeks but the bottom line looks far from encouraging: consumer prices fell more than expected in September, lending to the private sector grew at the slowest pace on record in August, and updated GDP figures revealed that the economy depended more on government spending while consumption and investment shrank at a faster pace than originally expected in the second quarter. While Trichet and company have consistently signaled that rates will remain unchanged well into next year, the steady upward drift in traders' 1-year yield expectations over the past two months suggests the markets will be disappointed if a hawkish streak does not begin to show itself in the near term, weighing on the Euro.
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