US Dollar Consolidates Gains, Bank of Japan Cuts Interest Rates to 0.10% (Euro Open)

Key Overnight Developments

• Japan’s All-Industry Activity Index Improves on Service Sector Growth
• UK Consumer Confidence Unexpectedly Rises in December
• Bank of Japan Cut Interest Rates to 0.10%, Pledges More Liquidity


Critical Levels 



The Euro was contained to a tight range in overnight trading consolidating loses from early in New York hours that saw EURUSD fall to 1.42 having reached as high as 1.4717. The British Pound saw more momentum, rising past the 1.50 mark to retake 1.51. Speculative positioning suggests the US Dollar is set to recover against European currencies.


Asia Session Highlights



Japan’s All-Industry Activity Index fell -0.5% in October, with loses led by a -2.5% decline in the manufacturing sector. This could be expected as the Tankan survey saw business confidence fall to the lowest since 1999 in the fourth quarter on declining demand for Japanese cars and electronics. Service demand improved a bit, adding 0.4% versus a -0.7% drop registered in September. However, as we mentioned at the release of the Tertiary Industry Index earlier this week, “traders are unlikely to see much follow-through as weakness in the labor market brings down wages and incomes, pushing consumer spending lower.

In the UK, GfK Consumer Confidence saw a mild improvement in sentiment as lower fuel costs and tax cuts boosted Britons’ willingness to spend. Shops have also introduced deep discounts to entice clients otherwise troubled by the deteriorating economy. Indeed, yesterday saw Retail Sales surprise to the upside, adding 0.3% in November. Economists had expected sales to fall -0.6%. It remains to be seen if sentiment can gain significant traction in the coming months as conditions in the labor market continue to deteriorate: Jobless Claims grew the most since 1991 and Unemployment ticked up to an 8-year high in November. Job loses will weigh on disposable incomes and trim consumption, easily the largest component of overall economic growth. An average of economists’ forecasts calls for recession to be confirmed in the UK as GDP readings print negative in the first and second quarters of next year. Overall, expectations suggest the economy will shrink -1.2% in 2009.

The Bank of Japan cut interest rates by 20 basis points to put borrowing costs at a meager 0.10%. Following of the US Federal Reserve, bank officials noted that with little scope for additional easing via explicitly lowering the benchmark lending rate, they were prepared to provide liquidity by alternative measures. The BOJ specifically cited a pledge to increase purchases of government bonds by 200 million yen and temporarily creating a facility to buy commercial paper.


Euro Session: What to Expect 



European economic data flow slows down into the end of the week, with German Producer Prices the only significantly market-moving item on the docket. Expectations call for a -0.8% monthly decline to bring the annual rate of wholesale inflation to 6.1%. A validation of expectations would mean price growth has slowed a hefty 31% since peaking in July as commodities sold off and economic activity turned sluggish. Slower producer prices suggest consumer inflation will decline in the coming months as firms pass on the savings from lower manufacturing costs in the price of the final product. Data released earlier this week revealed that German CPI declined for the fourth consecutive month in November and the broader Euro Zone CPI fell the most in nearly two decades. On balance, this suggests that despite recent hawkish commentary, more rate cuts are ahead for the European Central Bank. Overnight index swaps are pricing in 150 basis points in easing over the next 12 months, with rate cut expectations up close to 36% since last week.


To contact Ilya regarding this or other articles he has authored, please email him at ispivak at dailyfx dot com.