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British Pound in Focus with BOE Set to Expand Stimulus, Likely Inaction from ECB

The British Pound will be in focus in European hours as an interest rate decision from the Bank of England overshadows a similar announcement from the European Central Bank with UK policymakers expected to boost the size of their asset-buying quantitative easing program.
 

Key Overnight Developments

• New Zealand Unemployment Soars, Bollard Downplays Rates Forecast
• Australian Trade Deficit Widens as Imports Soar on Oil Shipments
• Euro, British Pound Decline Against USD Ahead of Interest Rate Decisions

Critical Levels



The Euro drifted downward in overnight trading, testing as low as 1.4811 against the US Dollar. The British Pound followed suit, shedding as much as -0.5% against the greenback.

Asia Session Highlights



New Zealand’s Unemployment Rate rose more than economists expected, registering at a 9-year high of 6.5% in the third quarter. The workforce shrank by -0.8% from the second quarter and -1.8% from the three months to September 2008. The disparity between preliminary forecasts and the actual result is notable: the economy shed twice as many jobs as economists predicted. Commenting shortly after the release, Reserve Bank of New Zealand Governor Alan Bollard was direct about the smaller antipodean nation’s problems, saying “Financial markets treat us like Australia, but actually we are quite different,” warning that the recovery in New Zealand is “slower and more vulnerable” than that of its larger neighbor. Such dour rhetoric seems aimed directly at dispelling investors’ expectations that interest rate increases from the RBNZ will keep pace with those of the RBA, which have helped drive the currency higher and threatened the export sector. Overseas shipments make up close to 30% of the economy’s total output; an appreciating currency makes exports comparatively more expensive and drives away foreign demand. For our part, we have long argued that the RBNZ will shy away from raising rates before the second half of 2010.

Australia's Trade Balance deficit expanded to –A$1.85 billion, the widest in 18 months, as imports surged 5.9% on the back of a jump in oil in inbound oil shipments with purchases of fuels and lubricants up 25% from the previous month. Overall, intermediate goods to be used in the production of finished products led other import categories, gaining 10% and hinting at a forthcoming pickup in manufacturing output. This may bode well for employment and ultimately help underpin spending after retail sales disappointed in September. However, it should be noted that the pickup is likely linked to the government’s commitment of A$22 billion to new infrastructure projects as part of its overall stimulus plan that had been put in place amid last year’s global recession and credit crunch; whether or not the economy will be able to stand on its own feet after expansionary policy is withdrawn remains clouded for the time being. The trade data offered some encouraging news on that regard, with exports were shown to have gained 4.7% as overseas gold sales rose by a staggering 64%. The spike was likely driven by investors’ increasing desire for an inflation hedge amid concerns that record-low interest rates and quantitative easing policies in much of the world’s top economies will drive devaluation of paper assets and produce runaway price growth. Spot gold prices hit a record-high $1092.20/ounce yesterday having rallied 24.8% so far this year.


Euro Session: What to Expect



The interest rate decision from the Bank of England will likely overshadow an analogous announcement from their counterparts at the ECB as Mervyn King and company prepare for what many market observers (including former BOE policy board member David Blanchflower) have speculated will mark a dovish shift in monetary policy. November’s decision is especially significant in that it coincides with the release of an updated inflation forecast. While many central banks are starting to ponder exit strategies after offering extraordinarily easy monetary conditions amid last year’s global economic crisis, the BOE has scope to move in the opposite direction after a very disappointing third-quarter GDP report. While benchmark rates will surely remain unchanged at 0.50%, the figure to watch will be the size of the bank’s quantitative easing (QE) program. BOE officials have done their utmost to project a dovish lean since August when they unexpectedly boosted the size of the asset-purchase scheme to 175 billion pounds; indeed, King himself has floated the idea of cutting the interest rate the BOE pays on bank deposits and tried talking down the currency, asserting that rebalancing the UK economy was “very necessary [and] the fall in the exchange rate…will be helpful to that process.” A survey of economists polled by Bloomberg calls for the QE program to be expanded to 225 billion pounds this time around, but given the program’s questionable performance record (net lending has failed to build meaningful traction, money supply growth remains lackluster), the introduction of a new element to the BOE’s overall strategy is not out of the question.

Turning to the European Central Bank, changes to headline interest rates are also unlikely. In fact, the ECB benchmark (officially unchanged at 1% since May) has not been representative of actual lending rates for some time, with the average cost borrowing Euros overnight oscillating between 0.6 and 0.3 percent since June. Rather, traders will focus on bank President Jean-Claude Trichet’s post-announcement press conference. The Euro Zone’s problems has been well documented and, while key economic data turned in mixed results in recent months, the bottom line is far from encouraging: consumer prices fell for the fifth consecutive month in October (threatening the onset of a deflationary spiral), lending to the private sector shrank for the first time on record in September, and the Euro has pushed to new yearly highs and threatened the export sector. The ECB has been slow-moving on these issues, opting to wait it out and see if the efforts of others (notably the US Fed) will boost the world economy and carry the currency bloc along for the ride without Jean-Claude Trichet and company having to make hard policy decisions that balance the interests of economically divided countries like Germany and Spain. However, this approach is far from fool-proof and the Euro will be surely punished if it fails, with the ECB likely relegated to (at the very least) keeping interest rates on hold longer than most of its major counterparts. On balance, another non-event is likely this time around save for the slim possibility that Trichet sounds off on the level of the exchange rate, but the dour landscape leaves the door continuously open for the ECB to shift to a more activist approach.

Rounding out the data docket, Switzerland’s Consumer Price Index will probably shrink for the eight straight month in the year to October, keeping the SNB firmly on hold and likely to intervene against the Franc any time the EURCHF exchange rate nears 1.50; UK Industrial and Manufacturing Production figures are set to show signs of continued marginal improvement on the back of close to $2 trillion in global fiscal stimulus enacted amid last years’ broad-based economic turmoil; and the annual pace of contraction in Euro Zone Retail Sales is expected to moderate to -2.4% in September, though a downside surprise is not out of the question after a dismal sales report from Germany for the same period.


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