While the currency markets await news and clarity about the Cyprus bank bailout, the latest Bank of England (BoE) minutes have surprised the markets and spurred a quick and sizable rally in the British pound.
The GBPUSD soared off the lows in morning London trade today after surprisingly hawkish monetary policy committee (MPC) minutes pushed the pair through 1.5150 on a quick burst of short covering.
Meanwhile, EURUSD stabilized and rallied back through the 1.2900 figure as the saga in Cyprus continued without any clear resolution in sight.
The release of the Bank of England (BoE) minutes took the market completely by surprise when it was noted that one key reason for leaving quantitative easing (QE) unchanged was that "It could lead to an unwarranted depreciation of sterling as if it were misinterpreted as a lack of commitment to maintaining low inflation in the medium term."
Although the UK economy remains in near-recessionary conditions, the monetary authorities are clearly concerned that further QE could trigger inflationary pressures, and with core CPI still above the key 2% level, those concerns are justified. Thus, despite the need for stimulus, it is likely that the BOE may refrain from further QE actions in the near future as it continues to watch price levels and the exchange rate of the pound, which has tumbled more than 10% since the start of the year.
Cable reacted quickly to the news, reversing off the lows to catapult more than 100 points before pausing at the 1.5150 level. If the Federal Open Market Committee (FOMC) announcement later today sends a dovish message from Fed Chairman Ben Bernanke, the cable rally could extend and the pair could challenge the 1.5200 level as the day proceeds.
Cyprus: Deposit Levy Still Not Off the Table
Meanwhile, in Europe, currencies were trading higher across the board this morning as FX traders wait for fresh news and some sort of clarity out of Cyprus. Discussions in Russia have yielded very little results so far, and according to comments from Germany, the EU won't let Cyprus off the hook so easily.
German Chancellor Angela Merkel said that in order to create sustainability, Cyprus' banking sector needs to contribute to the bailout, which suggests that they are still looking for a deposit levy. Officials now hope that a deal will be in place by the weekend, although we think that may be a bit optimistic.
In the meantime, the European Central Bank (ECB) has stated that it will provide necessary liquidity, but Cypriot banks remain closed and will stay that way for the rest of the week. Various European officials have been on the wires assuring the markets that there is no contagion risk from Cyprus, but in order for that to ring true, a solution to this problem must be found quickly.
The longer the Cyprus saga is allowed to drag on, the greater the loss of confidence and risk for contagion. The EURUSD rebounded above 1.2900 but now remains capped at the 1.2950 level. It is likely to be range-bound until there is more concrete news from Cyprus.
See related: A “Volatility Explosion” No Debt Crisis Can Stop
By Boris Schlossberg and Kathy Lien of BK Asset Management