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Waiting for the ECB rate decision

As we head into the second half of the week, foreign exchange markets are trading in narrow ranges as it awaits central bank meetings and US nonfarm payrolls on Friday.   The Canadian dollar is weak ahead of Bank of Canada this morning.   Although the central bank is not expected to deviate much from its last policy statement, the economic backdrop has deteriorated with job losses, contraction in consumer spending and a soft first quarter GDP print of 1.4%.  On a positive note, the housing market which has been a concern for the central bank has stabilized and consumer price growth has ticked higher.  The Bank of Canada will likely maintain rates at 1.0% and accentuate that rates will remain low for an extended period of time.   In domestic data, Canadian trade turned into a deficit of -$0.64 billion with imports topping estimates at $43.46 billion, from consensus of $42.7 billion.

North American futures are pointing to a negative open on the back of soft economic data.   Ahead of the all important nonfarm payroll report on Friday, ADP showed that the private sector added 179,000 jobs to the US economy, its weakest in four months, missing expectation of 210,000.   Further, April’s figures were revised downward to 215,000 from 220,000.   Trade deficit for the US surged to a two year high of $47.24 billion as the world’s largest economy imported a record amount of goods – in particular cars, mobile phones, and IT equipment.   On deck later this morning will be May Market Services PMI anticipated to rise from April’s print of 55.0 to 58.4, ISM non-manufacturing PMI and Fed’s Beige Book.

In Europe, traders are waiting on the sidelines ahead of the European Central Bank rate decision on Thursday with the pair of EUR/USD trading in a narrow 64 point range over the last six sessions.   Tuesday’s release of softer inflation figures combined with weak manufacturing PMIs should have led to a weaker euro as it firmed expectations for the ECB to act, however, the common currency proved resilient.   Service PMIs released this morning for Germany and the euro zone missed estimates with Germany posting a reading of 56.0 for the month of May, below the target of 56.4.   For the euro zone, the print came in at 53.2 against expectations of 53.5.   In other economic data, first quarter GDP was in line with the first estimate of 0.9% year-on-year and 0.2% month-on-month.

Markets have largely priced in that the ECB is likely to introduce a negative interest rate on deposits, lower the refinancing rate by 15 basis points and potentially launch a targeted program to ease credit constraints.   The ECB would be the third central bank of a relatively major economy to introduce a negative rate, following in the footsteps of Denmark and Sweden.   Denmark’s Nationalbank reduced the interest rate paid on deposits to -0.2% in an effort to curb the appreciation of the krone against the euro while the Riksbank embarked on negative rates in July 2009.   History has illustrated that though such policy action has resulted in depreciation of the Danish krone and Swedish krona, by 2.8% and 4.5% respectively, the impact has been short term.   It is unlikely that the euro will depreciate to the extent of the krone and krona as the euro is more liquid and further policy action could attract further capital inflows, thereby supporting the common currency.

The pound is flat on the day, comfortably trading above the 1.6700 handle, despite a strong PMI service print of 58.6, led by new business and jobs growth.   Today’s release follows a string of solid data in May for manufacturing and construction which confirms that the UK economy is on track to expand at a pace of 0.8% in the second quarter, a level not since before the financial crisis.   Although the Bank of England is slated to deliver its interest rate decision tomorrow, the ECB is likely to overshadow the BoE as Governor Carney and company is not expected to act.

Further reading:

ISM Non-Manufacturing PMI: 56.3 better than expected

ADP Non-Farm Payrolls only +179K – USD slides