Talking Points

  • Japanese Yen: BoJ To Buy Financial Shares
  • Pound: Finds Support On Increasing Construction Activity
  • Euro: Weighed by A Drop In German Retail Sales and Inflation
  • US Dollar: Housing Data On Tap

Euro Falls As German Retail Sales and Producer Prices Decline, Will ECB Cut Rates Again?

The Euro fell to support at 1.2800 on an unexpected 0.2% drop in German retail sales against forecasts of a 0.5% improvement. The single currency was receiving support before the release on the back of risk appetite driven by the BoJ's announcement that it would buy shares in Japanese banks. Before the central bank's statements the Euro had been under pressure as forex traders were anticipating the producer price report would show further easing of inflation, which would add pressure for another ECB rate cut. Indeed, markets weren't disappointed as costs dropped 1.3% in December bringing the annualized rate to 1.8% from 3.3% the month prior.

Falling oil prices continued to be the source of disinflation as the reading stripped of energy costs fell a modest 0.6%. The ECB has forecasted that core prices will begin to stabilize in the second half of 2009, which is expected to allow them to take a measured approach in the monetary policy. The central bank has already signaled that they will keep rates on hold at their meeting on Thursday. However, the weaker German consumption numbers demonstrates that the weakening labor market is weighing on consumption, which could lead to a sharp fall in domestic growth. If unemployment continues to mount across the region we may see country leaders demand for more action from the MPC. We may start to see support for the single currency as markets start to price hold, which became more certain when council member Mario Draghi stated that there was not much room left to cut rates.

The BoJ announced today that it would buy 1 trillion yen of shares owned by financial institutions. The central bank will continue purchases until 2010 as they reestablish a practice they ended more than four years ago. That news and the RBA lowering their benchmark by 100 bps helped fuel optimism and helped equity markets turn positive. However, British Petroleum, Europe's second biggest oil company, reported its first quarterly loss in seven years which has offset the optimism generated by the central banks.

After falling to as low as 1.4150 the Pound found support on the back of better than expected construction PMI reading. Indeed, the indicator rose to 34.5 from 29.3 in December. Nevertheless the BoE is expected to lower their benchmark rate by 50 bps on Thursday, which will remain a weighing factor. Yet, the string of improving data from the region may give the MPC reason to pause which will keep markets guessing and may lead to the continuation of recent volatility for the currency.

The dollar may slip today as fears have slightly eased which may lead to equities trading higher on the day. The fundamental calendar may help fuel risk appetite as the U.S. pending home sales report is expected to show a flat reading for December which will be welcome news for the markets, after the gauge posted three consecutive months of plus 4% declines. However, a Vehicle sales report that is expected to show the lowest demand in 27 years may temper any optimism. The data may remind trades of the impact of the slumping industry on the economy and lower expectations for Friday's NFP print that could fuel risk aversion and add dollar support.