Will the Euro Retreat as Inflation Falls to Lowest in Over a Year? (Euro Open)

Key Overnight Developments

• Japanese Policymakers Again Hint at Currency Market Intervention
• Australian Economic Growth Slowest in 16 Years, Says Westpac


Critical Levels 



The Euro retained strength overnight after the breakneck rally in New York trading hours, spending most of the session consolidating at intraday highs near 1.41 (though a brief spike did come in within a hair of the 1.42 level). The British Pound mirrored Euro price action, with a short-lived spike above 1.57 being the only disturbance in an otherwise narrow consolidation 1.56.


Asia Session Highlights 



Comments from leading Japanese policymakers overnight confirmed that leading figures in the government and at the central bank are considering currency market intervention to suppress the surging Yen: Cabinet Secretary Kawamura noted that the BOJ should factor in recent moves in the domestic currency when setting monetary policy; meanwhile, Vice Finance Minister Naoyuki Shinohara reiterated again that action against further appreciation can be taken if forex price action is deemed “undesirable”. We have suggested as recently as this week that with limited fiscal and monetary options going forward, slowing the Yen’s ascent to boost the export sector is becoming an increasingly viable alternative. The Bank of Japan is set to announce monetary policy between today and tomorrow.

Australia’s Westpac Leading Index fell for the third consecutive month in October, suggesting annualized economic growth has slowed to just 0.6%, the slowest in over 16 years. Still, yesterday’s release of minutes from the last meeting of the Reserve Bank of Australia continued to signal that rate policy has moved to neutral. 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. Regardless, traders raised bets for future easing by a whopping 26% just since last week, with overnight index swaps pricing in 100-125 basis points in cuts over the next 12 months.


Euro Session: What to Expect 



The economic calendar is packed once again in European hours. The Euro Zone Consumer Price Index is expected to issue a monthly drop of -0.5% to bring headline inflation to 2.1% in the year to November, the lowest in 14 months. Price growth peaked in July and reversed sharply lower as commodities (particularly oil) sold off and economic activity deteriorated. Indeed, the Euro Zone fell into the first-ever recession since the advent of the single currency after GDP contracted in the second and third quarters. The economy is likely to continue to suffer: the European Commission calls for growth to slow to 0.10% 2009 and an average of economists’ predictions is grimmer still, pointing to a -0.4% decline. 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 at least 125 basis points in easing over the next 12 months, with rate cut expectations up 21% since last week.

In the UK, minutes from the last meeting of the Bank of England are due for release. Mervyn King and company have sounded definitively dovish in recent weeks. Just yesterday, the Governor wrote in an open letter to the Chancellor of Exchequer that in 2009, he expects to be offering explanations on why inflation is below the 2% target rather than above it. Further deterioration in the labor market would bolster King’s assessment, with Jobless Claims expected to rise by the most in 16 years and the Unemployment Rate ticking up to 6%, the highest since 1999. Job loses will weigh on disposable incomes and trim consumption, sinking economic growth and slowing prices. Indeed, annualized inflation has decelerated 21% in just two months to print at 4.1% in November, the lowest since June. Still, traders have pared back expectations of future easing: overnight index swaps now price in just 50 basis points in rate cuts over the next 12 months having called for 175bps less than 2 weeks ago. The BOE has trimmed a hefty 3% off borrowing costs in a mere 2 months, the sterling has declined, and the government offered fiscal stimulus; it seems the markets now see scope for the central bank to wait and see how things play out.


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