Forex traders pushed the Australian dollar higher despite a hefty 1.00% interest rate cut as the RBA signaled it was done lowering borrowing costs for the time being. Inflation data is on tap for European hours with Euro Zone Producer Prices and Swiss Consumer Prices set for release.
Key Overnight Developments • Reserve Bank of Australia Cuts Rates 1%, Hints Easing is Over • Australian Retail Sales Unexpectedly Rise in October • Current Account Deficit Shrinks in Q3 on Coal, Iron Ore Exports Critical Levels The Euro and the British Pound remained range-bound against the US Dollar in overnight trading despite a hefty selloff across stock markets. The divergence between the greenback and risk appetite is uncharacteristic given recent trends. Indeed, the correlation between EURUSD and the MSCI World Stock Index is slightly lower today, down -0.32% from yesterday. While it is certainly far too soon to say the relationship is breaking down, it is an important development that could foreshadow significant changes in price dynamics over the coming weeks. Asia Session Highlights The Reserve Bank of Australia cut interest rates by a greater-than-expected 100 basis points today, bringing borrowing costs to six-year low of 4.25%. As had been suggested in the minutes from the bank’s last meeting, RBA policy will shift to neutral going forward. The statement accompanying the release offered now familiar cautionary rhetoric about the dire state of the global economy but concluded with the clearest signal yet that the current rate cut cycle has concluded. Governor Glenn Stevens said that “a major easing in monetary policy…together with spending measures announced by the Government and a large fall in the Australian dollar” will support demand over the year ahead. Stevens further said that the bank will “make adjustments as needed to promote sustainable growth consistent with achieving the 2–3 per cent inflation target.” Put simply, this means that the RBA is not ruling out raising rates should the current disinflation reverse course. The Australian Dollar initially dropped 26 pips on the release but quickly recovered, rising 73 pips to surpass the 0.64 mark as traders re-priced interest rate expectations. Stevens had previously suggested that the impressive magnitude of recent rate cuts, a full 3% since early September, was designed to quickly offer the necessary stimulus without extending rate cut expectations too far into the coming year. The reasoning behind this seems to be the inflationary effect of the sharp depreciation in the Australian dollar. Entrenched rate cut expectations would put continued pressure on the Aussie, making it harder for the bank to strike the right balance between boosting growth and bringing inflation back within the target range. This looks to have moved the RBA to favor a “big bang” rather than a gradual approach to monetary boost. The Current Account Balance produced a narrower deficit than economists expected, showing a –A$9.8 billion deficit in third quarter versus expectations of a –A$11.1 billion shortfall. The gap has contracted by nearly half since a year go, shrinking -44.9%. The improvement was driven the lingering effects of China’s ravenous demand for Australian coal and iron ore. Indeed, recent reports have shown mining companies’ profits rose 19% in the three months through September. Looking ahead, brisk export growth is likely to fade as China’s own economy succumbs to the global economic slowdown. Still, Australia’s external balance may continue to improve: a gloomy outlook for the domestic economy and a weaker Australian dollar is likely to take a toll on Australians’ demand for imports. Retail Sales unexpectedly rebound in October, adding 0.7% versus forecasts of a -0.2% decline. Sales had previously fallen 1.0% in September, the lowest reading in over 3 years. The improvement was driven by an impressive 7.6% uptick in the descriptively titled “Other Retailing” subset of the release that includes spending on items as diverse as pharmaceuticals, cosmetics, gardening supplies, and jewelry. Most interestingly, this category also includes sales of used goods, which could suggest that the sluggish economic environment is pushing thrift-minded Australians to prefer second-hand products over new ones.
Euro Session: What to Expect Switzerland is expected to see the Consumer Price Index drop -0.2% in November, bringing the annual inflation rate to 2.0%. The Swiss National Bank predicted on November 20th that the selloff in commodities (and oil and in particular) will mean that “price stability will be restored sooner than expected, and inflation is likely to fall below 2% as early as the end of this year.” The announcement accompanied a massive surprise rate cut, with Jean-Pierre Roth and company slashing borrowing costs by a full percentage point to address the “higher risk of a marked slowdown in economic activity” from appreciably worsening international conditions. Indeed, 4 out of the top 5 of Switzerland’s main trade partners are now in recession, threatening dry up demand for exports. Economists expect the pace of Swiss economic activity profoundly stagnate in the second half of 2008 and into 2009, with GDP growth slowing a whopping 75% before the first signs of recovery begin to emerge in the third quarter of next year. On an annualized basis, the economy is expected to add 1.8% this year and yield a nil result for 2009, down from a respectable 3.3% expansion in 2007. While the markets continue to price in no changes in benchmark borrowing costs, traders may see the SNB continue to surprise with monetary easing should the acute economic downturn send inflation too far below the 2% mark. Looking at the Euro Zone, the Producer Price Index is expected to decline -0.3% in October to bring the annualized rate to 7.0%, the lowest since April. PPI peaked in July with the global rally in commodities and has since seen steep decline. The index is seen as a leading indicator of consumer inflation: if manufacturing costs decline, firms are expected to pass on at least some of the savings by way of a cheaper final product. Economists expect headline inflation to fall below the 2% threshold for “price stability” by the second quarter of next year. This means more interest rate cuts are likely on the way, with the European Central Bank expected to trim at least 0.50% off borrowing costs later this week and offer between 125-150 basis points in additional easing over the next 12 months. To contact Ilya regarding this or other articles he has authored, please email him at ispivak at dailyfx dot com.