Next week we get 4 central bank's decisions - from Australia, Canada, United Kingdom, and the euro zone - and each one will be watched closely and at least three are likely to shift the dynamics behind their respective currencies.
I expect the ECB and the Bank of Canada to be more dovish, the RBA to move into a neutral stance, the ECB to ditch its tightening campaign, and there is some speculation that we may see more quantitative easing from the bank of England.
Let's take a look at these one by one.
RBA To Shift to Neutral Stance
Expectation a few short weeks ago for the Reserve Bank of Australia was for the central bank to cut interest rates as a result of the turmoil in financial markets, as well as a slowdown in the domestic economy. Consumer confidence has been on the decline, stocks have been falling, housing has been stagnant with house prices falling, and the manufacturing and construction industries have been in contraction. Putting all that together there was pressure on the RBA to lower rates in order to help the economy, and that was what futures prices had priced in.
As we outlined in our article on Monday, last Friday which was August 26, RBA Governor Stevens came out and say that the bank's expectations for growth are now weaker than their statement on monetary policy published in early August, that inflation would not be as strong because of declining asset prices, slowing credit growth, and elevated exchange-rate exerted a degree of restraint on financial conditions. However he also mentioned that inflation continued to need careful watching and that overall inflation continued to be a concern to central bank policy makers. That meant no rate hikes, but also no rate cuts either.
Market Impact: I therefore expect the RBA to walk a fine line in its statement, putting itself in a neutral stance, a wait-and-see mode. Since that stance is more hawkish than expectations of an interest rate increase the Australian dollar has been gaining as a result. If this view has not changed over the last week and through Tuesday's rate decision we should continue to see the expectation that the RBA will hold rates at 4.75%. That will be supportive for the Australian dollar which can extend its gains following some recent consolidation within an upward bias.
BOC Expected To Soften Its Language From July Statement
In its July 19th interest rate statement the Bank of Canada dropped the term eventually in saying it would take away monetary stimulus if economic expansion continued.
To the extent that the expansion continues and the current material excess supply in the economy is gradually absorbed, some of the considerable monetary policy stimulus currently in place will be withdrawn, consistent with achieving the 2 percent inflation target.
On August 19 the governor shifted the stance of the central bank by saying that the bank would be prudent with respect to the possible withdrawal of any degree of monetary stimulus.
Yields on overnight index swaps, which trade based on expectation for the and chart interest-rate, show investors expect the central bank to cut rates either later this year or sometime in 2012, though I hold the stance that rates will stay where they are at 1%.
The economy contracted in the second quarter, which was unexpected therefore it's important to see just how the dovish the central bank statement will be. The bank had expected inflation to return to its 2% target by mid-2012 and for core inflation to hit 2% by the fourth quarter of this year. If the recent weakness in the economy means that inflation will come down to these levels sooner that could put the bank into a less hawkish posture. Weakness in the US economy, most recently seen in the very weak nonfarm payroll growth, adds extra headwinds for the Canadian economy as well.
Market Impact: If the bank sounds even more cautious than Carney did on August 19, this the expected to weaken the Canadian dollar. Any suggestion that the bank will plow ahead with rate hikes in the not-too-distant future would strengthen the Canadian dollar.
ECB To Squash Expectations of Further Rate Hikes
With the deterioration in the economic situation in the euro zone - from weaker than expected second-quarter growth, to weaker manufacturing, to a slowdown in Germany's confidence indicators - the interest-rate increases by the central bank this year are now being questioned.
The latest data also continues to show the view that inflation seems to have peaked in the early part of the second quarter. The conclusion is that the ECB is not only done hiking rates the rest of this year, that it may see the need to even lower interest rates if the macro situation continues to deteriorate and inflation cools further.
Euribor futures show markets have priced out further interest-rate hikes the next couple of years and also see around 30% chance that the bank may be forced to cut rates early next year.
Market Impact: I expect the ECB to soften its stance in regards to inflation. In its last meeting the ECB said that it would monitor inflation carefully, leaving the door open for interest-rate increase in October. By putting their expectations of inflation under review, and most likely lowering them, the ECB will take away the expectation of further rate hikes which may help economic growth. However, it would undercut a fundamental strengths of the euro which it has had throughout this year. Following the rate decision the Euro could come under pressure, especially against the higher-yielding commodity bloc currencies.
Will BOE Move Towards More Quantitative Easing?
The UK economy has also been struggling with a rash of poor data. The manufacturing sector contracted for second month in a row we continue to seek consumers is domestic and export orders have fallen, which is increasingly worrisome because export growth is expected to lead bit UK economy is domestic spending is week because of higher unemployment, higher inflation, and stagnant wage growth. Government spending is also being scaled back on account of austerity measures.
As the recent amount of data since the Bank of England that they need to act in order to help forestall a move back into negative growth territory in the third quarter. The economy expanded only 0.2% in the second quarter and with Outlook for further fiscal consolidation its monetary policy that would have to aid a fragile recovery.
Market Impact: Strongest step the DOE could take would be to expand its policy of quantitative easing from £200B by £50B to £250B. such a step would weaken the pound in the currency markets. if there is no change we will not get a accompanying statement from the BOE and therefore we would have to wait two weeks to get the minutes where we would hear the discussion between the members and whether more members had moved to the dove-ish camp.
Chief Market Analyst