British Pound Volatility Ahead as Bank of England Updates Monetary Policy

Key Overnight Developments

• Australian Retail Sales Disappoint, Building Permits Rise on Stimulus
• NZ Labor Market Probably Stronger Than Spike in Jobless Rate Suggests

Critical Levels



The Euro was little changed in Asian hours, trading within 20 pips of the 1.3890 level to the US Dollar. The British Pound followed suit, oscillating in a narrow range around the 1.5900 figure. We remain short EURUSD at 1.4881.


Asia Session Highlights



The New Zealand Dollar tumbled in early Asian trading after the Unemployment Rate unexpectedly soared to 7.3% in the fourth quarter, topping economists’ forecasts of a 6.8% outcome. Details of the report hint that the outcome may not have been as dour as the market’s initial reaction would suggest. The ranks of the employed shrank by 2,000 people but those of the unemployment grew by a far more formidable 18,000 persons. A good portion of this discrepancy is likely attributed to a 13,000-person increase in the overall labor force (the sum of employed and unemployed people), which probably occurred as improving economic conditions encouraged workers that had previously given up looking for a job (and so were excluded from the labor force) to begin searching once again. This means the down move in the Kiwi dollar is unlikely to see much follow-through beyond the initial spike lower as the outcome fails to meaningfully derail the market’s RBNZ monetary policy outlook. Indeed, a Credit Suisse gauge of priced-in rate hike expectations over the coming year actually rose 6 basis points in the aftermath of the release.

Australian Retail Sales unexpectedly dropped in December, slipping -0.7% from the previous month versus expectations of a 0.2% increase to register the first decline in five months. Department store sales led the metric lower, slipping -3.5%, while apparel and food sales lost -1.9% and -1.3% respectively. The figures bode ill for the Australian Dollar, painting a dour picture of the Australian consumer even as stimulus is withdrawn and the self-sufficiency of economic growth is tested. Indeed, December’s surge in Building Approvals seemed to be ignored despite a 2.2% increase amid expectations for a flat result and a sharp upward revision to November’s outcome (10.4% versus 5.4% originally reported). The outcome likely failed to impress as permits for publicly-funded construction grew at an annual pace that was nearly nine times that of the private sector, hinting that most of the gains were had on the back of infrastructure spending allotted in last year’s fiscal package. Investors seem far more concerned with the continuity of the recovery at this point, with today’s figures adding to headwinds facing the high-yielding currency after business confidence floundered and the central bank unexpectedly failed to deliver higher interest rates.


Euro Session: What to Expect



The interest rate decision from the Bank of England headlines the economic calendar in European trading. Last week, the BOE completed asset purchases undertaken in November when it added £25 billion to its quantitative easing (QE) program. At that time, the central bank committed to a three-month time frame to complete the expansion, taking a fair bit of uncertainty away from subsequent rate decisions. There is ample room for volatility this time around however with purchases complete and the BOE sizing up an updated quarterly inflation report (which the public will not get to see until next week) to set the broad outlines of monetary policy from here.

The general consensus favors a shift to wait-and-see mode from here as early signs of stabilization begin to emerge. Indeed, Gross Domestic Product grew 0.1% in the three months to December 2009 after six consecutive quarters of contraction, the latest CPI figures revealed that inflation grew at an annual pace of 2.9% - the highest in nine months – and jobless claims fell for two consecutive months starting in November. Lending conditions have also started to improve a bit, with consumer credit expanding for the first time in five months in December. On balance, this gives Mervyn King and company some room to sort through the conflicting cues abundant in more volatile leading indicators, shifting the policy setting to neutral for the time being.

The European Central Bank is also due to issue their interest rate announcement but any meaningful changes to monetary policy seem unlikely. Indeed, the ECB can afford to remain on the sidelines now that CPI readings have recovered from negative territory and the difficult task of balancing the competing growth and inflation objectives of stronger and weaker Euro Zone economies gives them every incentive to do so. The post-announcement press conference with ECB President Jean-Claude Trichet may is likely prove market-moving as the focus invariably falls on swelling deficits among the southern European members of the currency bloc, particularly after EU Monetary Affairs Commissioner Joaquin Almunia said Greece and Portugal’s external funding needs are “big”. Last month, Trichet stressed that "no government, no state can expect any special treatment," feeding concerns about the structural integrity of the single currency if its sickly members are unable to bring their fiscal position closer to the 3% of GDP cutoff level.


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