Research Note ECB/BOE preview: How will Draghi mark his one year anniversary?

on November 08 2012 8:08 AM
EURUSD: daily cloud chart
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This Thursday 8th November the ECB is scheduled to announce its interest rate decision at 1245GMT/ 0745 ET. Economists, polled by Bloomberg, expect interest rates to remain on hold at 0.75% and for deposit rates (the rate the ECB pays banks to leave their deposits with it) to remain at 0%. No other policy announcements are expected.

The economic data in the Eurozone has deteriorated since the last meeting. The PMI data for both the manufacturing and services sectors both declined in October relative to September. Added to this, there are some signs that France is slipping away from Europe’s core group of economies towards the periphery. France’s service sector PMI dipped to its lowest level for a year, and the manufacturing sector remains close to its lowest level since mid-2009. Although Spain and Italy saw some improvement in their surveys, they remain at extremely low levels.

We don’t think this will be enough to force the ECB into cutting interest rates to a fresh historic low below 0.75%, the current rate, as we believe this may attract opposition from the hawkish elements of the ECB including the powerful Bundesbank, Germany’s central bank.

We expect the ECB to say that the decision on rates was unanimous, which may reinforce to the market that the ECB is unlikely to cut rates anytime soon and there is little urgency to implement new measures to try and stem the sovereign crisis.

We believe it would be wrong to say that Draghi has dragged his feet in his first year of office. Interest rates have already been cut a historic low of 0.75%, he has authorised EU 1 trillion of liquidity for the banking sector through the LTRO programme, he loosened collateral requirements to make it is easier for troubled banks to get access to funds and he helped create the Bank’s most powerful tool so far to target this crisis the Outright Monetary Transactions programme (OMT). On that note, this will be the third month when the OMT programme has still not been triggered. For it to happen Spain or another troubled member state would need to make a formal request for aid from the EU’s bailout funds. Spanish PM Rajoy said earlier this week that a sharp rise in bond yields would be one condition necessary before Spain would consider making a request for financial aid. 10-year Spanish bond yields remain stable at approx. 5.65%, which means that a near-term aid request from Madrid is unlikely.

Thus, the ECB may remain fairly calm when it comes to the OMT and its activation, reiterating that before it is triggered a member state must sign up to the conditions that come with a bailout. We expect ECB President Draghi to continue to put pressure on governments to implement austerity programmes. We don’t think he will mention anything about Greece and its next tranche of bailout funds, which have yet to be signed off by the EU and IMF. He is unlikely to comment on the Greek budget vote, which takes place before the ECB meeting on Wednesday. Likewise, we don’t think he will comment on a potential diplomatic spat between the government of Spain and the ECB, after Madrid did not vote for Yves Mersch to join the ECB’s six-member executive board.

The potential market reaction:

The euro has fallen since the last meeting, when the ECB stayed on hold and did not enact any new policies to try and stem the sovereign debt crisis. Although EURUSD tried to rally last month, it ran into stiff resistance at 1.3175. 1.2750 is currently acting as support.

We believe that the ECB meeting may put further downward pressure on the single currency as it is extremely sensitive to credit risk in the Eurozone. For now the market may be willing to give Spain and the ECB the benefit of the doubt so it does not need to trigger the OMT programme, but we believe eventually Spanish yields will rise forcing it into a bailout and triggering the OMT. This meeting may focus minds that the ECB is not actually doing anything concrete to support peripheral bond markets or help growth in the region and this may spook investors.

The Obama victory in the US election caused a short lived bounce in risky assets and a decline in the dollar. However, this attracted selling interest as the markets weighed concerns about Greece and the ECB failing to add more policy stimulus for the currency bloc. A break below 1.2750 would be a very bearish development for this cross and could open the door to 1.2610 – the base of the daily Ichimoku cloud and a key support zone.

EURUSD: daily cloud chart

Source: Forex.com

A close call at the Bank of England

On Thursday at 1200GMT/ 0700 ET the Bank of England will announce its policy decision. The Bank is expected to keep rates on hold at 0.5% and the market is no longer looking for an increase in asset purchases. In recent weeks the market has scaled back on its expectation for more QE at this meeting due to the strong Q3 growth figure and some signs that the BOE/ government Funding for Lending programme is starting to have an impact. Mortgage approvals have risen in recent months and consumer credit for September had its largest monthly jump (GBP1.2 bn) since February 2008.

Although the negative surprises in the October service and manufacturing sector PMIs suggest that growth may be stalling at the start of the fourth quarter, we believe there are enough members on the fence at the BOE to wait and see if the stronger lending data feeds into improved activity levels in the coming months. Thus, the Bank may remain in wait-and-see mode this month.

If the Bank remains on hold at this meeting then we will not receive a statement on Thursday. Instead we will have to wait for the last Inflation Report of the year on 14th November and the BOE minutes on 21st November to get a window on the Bank’s thoughts. In recent speeches some members have expressed doubts that more QE can help the UK economy, we will be looking to see if they have more faith in the Funding for Lending Scheme  instead and what this means for the UK’s growth forecasts for 2013.

The potential impact on the pound

If the Bank remains on hold as we think there may be some buying pressure on the pound in the short term. Resistance in GBPUSD lies at 1.6070 (the 50-day sma) in the short term. The bigger surprise would be if the Bank did increase its asset purchase programme by either GBP25 or GBP50 billion. If that happens then we may see a sharp selloff in the pound. Support lies at 1.5900 then at 1.5850 (a cluster of daily smas) in GBPUSD. In EURGBP resistance lies at 0.8040 – the 200-day sma.

Best Regards,

Kathleen Brooks| Research Director UK EMEA | FOREX.com

d: +44.(0).20.7429.7924 | f: +44.(0).20.7929.2010 | M: +44 (0) 7919.411.957  | e: kbrooks@forex.com| w: www.forex.com/uk

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