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Euro, British Pound Brace for Interest Rate Cuts (Euro Open)

Thursday, 06 November 2008 05:35:52 GMT  |  Ilya Spivak, Currency Analyst

The Euro and the British Pound retreated from their US session highs in overnight trading as the forex market prepares for rate cuts from the European Central Bank and the Bank of England. Paradoxically, recently forged cross-market correlations between stocks and currencies could see EURUSD and GBPUSD actually rise following the announcements.

Key Overnight Developments

• UK Economy in Recession, Says NIESR
• New Zealand Unemployment Highest in Over 4 Years, More Rate Cuts Ahead
• Australia Unexpectedly Adds 34k Jobs in October


Critical Levels



The Euro traded lower in the overnight session, settling in a choppy 50-pip range above 1.2840 having touched as high as 1.3115 in New York hours. Sterling followed suit, retreating from highs near 1.62 to rest above the 1.58 mark.


Asia Session Highlights



The UK economy shrank -0.5% in the third quarter according to NIESR, a London think tank, meaning the economy has likely sunk into recession. Citing the poor result and the “intensifying banking crisis”, NIESR’s chief economist Martin Weale called on the Bank of England to cut interest rates by half of a percentage point at tomorrow’s meeting. Mervyn King and company may yet one-up demands for monetary easing, with overnight index swaps pricing in a 75 basis point cut when policy is announced at 12:00 GMT.

New Zealand’s Unemployment Rate ticked higher to 4.2% from 3.9% in the three months through June, the highest in four and a half years. Rising unemployment will have a detrimental effect on disposable incomes, crimping consumer spending and slowing economic growth. Indeed, New Zealand is now formally in recession as GDP shrank in the first and second quarters. The Reserve Bank of New Zealand has aggressively lowered borrowing costs 1.75% since July and is expected to slash rates by another 75-100 basis points at the next meeting on December 3rd.

Australia’s labor market showed unexpected resilience in October: the Employment Change figure registered the biggest gain in 6 months, showing the economy added 34.3k jobs. The Unemployment Rate remained unchanged from the previous month at 4.3%. Economists’ forecasts had called for employment to shrink by -10k to push the jobless rate to 4.4%. Not all is as rosy as it seems, however: most of the gains were had in part-time employment, were the economy added 43.5k jobs. Meanwhile, full time jobs actually lost -9.2k employment places. The shift from full-time to part-time employment suggests that companies are scaling back on labor expenses, a move consistent with expectations of slowing global demand. Still, a change in preferences to favor part-time labor is better than outright job cuts, putting some money in the pockets of consumers and keeping alive hope that Australia can side-step recession much as it did when the world last suffered collective slowdown in 2001.


Euro Session: What to Expect



Needless to say, forex markets will be squarely focused on the upcoming interest rate announcements from the Bank of England and the European Central Bank. Both sets of policymakers are faced with all but assured recession, so hefty rate cuts are decidedly in the cards. Economists’ forecasts point to a 50-basis point reduction apiece, though priced-in expectations derived from trading in overnight index swaps open the door for some surprises. Though markets seem to agree with forecasts for the ECB decision, traders are betting that Mervyn King and company will slash the BOE benchmark by a whopping 0.75%. It remains to be seen whether the British Pound or the single currency will be spooked by the announcements, for rate cuts have been expected for some time. Paradoxically, traders may actually see EURUSD and GBPUSD rise on the news as lower borrowing costs buoy sentiment on stock markets and send capital out of safe-haven destinations (i.e. the US Dollar).


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

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