Suddenly, just when all seemed so calm in currency markets, the mood twisted violently. Not surprisingly, it was the single currency that was again in the dock yesterday, sinking to a low of 1.2364 from above 1.25 earlier in the day. European policy-makers ought to be incredibly disappointed by the price action, and over the past couple of days especially. In effect, the euro has given back all and more of the boost it received after last Friday’s more positive than expected EU Summit announcement. Thursday’s sudden plunge was something of a surprise in that a 25bp rate cut from the ECB was widely expected.
Also hurting the single currency and aiding the dollar were two separate pieces of US employment data which both came out on the stronger side of expectations. Ahead of today’s payrolls numbers, a number of traders clearly decided they did not want to be short dollars. Weighing on the euro as well was an assertion from Frau Merkel that she did not take on any additional commitments at the EU Summit. All at once, many questioned what exactly was agreed/achieved. Although the price action of the past few days has been poor, it is not yet terminal.
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So far, the euro is still comfortably above the low of 1.2288 recorded on the first day of June. Those of a bearish persuasion towards the euro will want to see this level taken out soon to justify their negativity. At the same time as the euro is suffering, also notable is the renewed appetite for the dollar. For instance, the dollar index was up by more than 1% yesterday, a big move. Should payrolls reaffirm the positive jobs news contained in yesterday’s releases, then the need for additional QE in the near term will be diminished. Alternatively, the doves on the FOMC will be invigorated should we get another weak jobs figure. Elsewhere, the high-beta currencies were unsure how to react. The Aussie, for example, jumped to 1.0330 immediately after the China rate-cut announcement, but then crawled back into its shell.
Commentary
Getting UK QE to work. . The announcement of a GBP 50bln increase in asset purchases from the Bank of England was no great surprise, not least after last month’s vote at which four members (including the BoE governor) voted for more QE. The last program of asset purchases ended in early May, so the intervening two months have constituted the longest period without weekly bond-buying by the BoE since QE2 started eight months ago. But the Bank’s statement underlined its thinking, namely that there is more slack in the economy, it has stalled and inflation is falling. But with interest rates near zero and asset purchases well advanced, policy-makers are becoming more concerned with the channel by which such efforts help the real economy. In terms of feeding through to businesses and consumers, there have been few signs of improvement. The 2Y fixed mortgage rate has increased 0.75% over this time, according to Bank of England data, whilst the Bank’s credit conditions’ survey has shown no real pick-up in corporate credit-availability, regardless of the size of the firm. As such, the ‘funding for lending’ scheme currently being worked on by the Treasury and the Bank could end up being just as important as yesterday’s expansion of QE. Indeed, it was welcomed in the Bank’s statement. There’s also the impact on other asset markets to consider, the so-called ‘portfolio-rebalancing’ effect as other assets are purchased with the money advanced from gilt sales. Over this time, stocks (FTSE All Share) are up 8%, although this is only half the gain experienced by the S&P500 over the same period. Sterling outperformed most currencies after the announcement, with the exception of the dollar and the Japanese yen. The impact of QE on currencies is far less clear cut than before, so the main challenge for sterling continues to be whether EUR/GBP can manage a sustained break below 0.8000 level which, independent of a fresh round of euro-crisis fears, is looking a tough barrier to break.
Draghi’s ‘first’ ECB rate cut. Draghi’s first two easings (November and December last year) were merely unwinding the mistaken rate increases undertaken by his predecessor earlier in 2011. It’s just a shame that it took so long to get to this stage. Beyond the anticipated 0.25% cut in the key benchmark rate (to 0.75%), the ECB also cut the deposit rate to zero, the amount that banks are remunerated for parking funds overnight at the ECB. Deposits have remained high, seen as a reflection of the continued reluctance of banks to lend to each other, rather than lend to the wider economy. But the ECB can only reduce the incentive; the rest is down to the banks.
The market was not fully positioned for a cut in rates and this partially explains the negative reaction from the single currency. Hopefully there is no-one that thinks yesterday’s move will solve Europe’s many problems, but it goes some way towards giving the banking system a small kick in the right direction and a marginal boost to economic confidence. What will matter in the coming days is how deposit-levels at the ECB react (beyond the end of the reserve period on Tuesday next week), together with market rates (such as EONIA), because it’s here that the first indications will be whether the new policy is working in the monetary engine room.
Another welcome move from Beijing. China surprised yesterday with the announcement that it was reducing key deposit and lending rates for the second time in a month. Although the timing of the announcement (so soon after the last move) was a surprise, the fact that it has lowered rates again is certainly not. In addition, the PBOC declared that banks will be permitted to offer loans at a discount of up to 30% (relative to benchmark rates). Whilst the economy may well have started to stabilise over recent weeks after losing momentum progressively through the first half of the year, clearly policy officials believe that a further easing of financial conditions is warranted. Next week, second-quarter GDP will be released and is expected to show a further deceleration of growth. According to some estimates, the growth rate of GDP in the last quarter may have slowed to below 7.5% from the 8.1% rate in Q1. In addition, there are further signs that inflationary pressures are moderating – the June CPI may have fallen to just 2.5%, from 3.0% in the previous month. Now that policy-makers feel they have inflation under better control, they are more inclined to step in with more aggressive policy initiatives. This latest move on rates from Beijing is very welcome. We can expect more in the months ahead, including some reductions in bank reserve requirements. It will help placate some of the underlying caution towards risk that is still infecting the market.
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