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Why an ECB Rate Cut May Not Work

Why an ECB Rate Cut May Not Work

2013-04-29 20:45:00
Kathy Lien, Technical Strategist
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While the Fed is widely expected to leave rates unchanged at this week’s meeting, the European Central Bank (ECB) must consider swift and even unconventional measures to stimulate the struggling Eurozone economy.

The action-packed week in the forex market has started off slowly for EURUSD and USDJPY, due, in part, to Chinese and Japanese markets being closed overnight. Rest assured, however, that volatility is very likely to increase as the week progresses.

The US dollar (USD) is actually the worst performer, weakening against all major currencies on the back of disappointing economic data. US personal income growth slowed from 1.1% to 0.2% in the month of March, while personal spending growth slowed to 0.2% from 0.7%. Pending home sales increased 1.5%, but any enthusiasm from the rise was offset by a large downward revision to the prior month's report.

For the Federal Reserve, which meets later this week, today's economic data confirms that the US recovered lost momentum at the end of the first quarter. However, without seeing this week's ISM numbers or the all-important non-farm payrolls (NFP) report, the Fed won't rush to any judgments.

As a result, we do not expect any major changes to the central bank's monetary policy stance. Yet, this week's ISM and payroll reports will go a long way in shaping the market's expectations for Fed policy in the months to come.

Non-farm payrolls will be the report to watch for US dollar traders, but given that it comes at the very end of the week, country-specific factors—rather than risk-on/risk-off sentiment—should drive currency flows for most of the week.

See also: The 4 Biggest FX Events This Week

Why an ECB Rate Cut May Not Work

The euro (EUR) is trading well despite further weakness in Eurozone data and the prospects for a rate cut by the European Central Bank (ECB) later this week. Forex traders may be wondering how the euro can be so resilient, especially given these expectations. Part of its strength has to do with the formation of a new government in Italy, but also the skepticism about how much of an impact a rate cut would actually have on the economy.

First and foremost, of the 70 economists surveyed by Bloomberg, 62.8% expect the central bank to lower interest rates. This is hardly an overwhelming majority. The Euro Overnight Index Average (EONIA) rate has already been trading near zero for the past nine months, so a rate cut can't drive rates much lower unless the central bank is willing to accept negative interest rates.

We are not ruling out the possibility, but at this point, the euro is trading like it needs more aggressive action than just a rate cut from the ECB to break below 1.2950.

By Kathy Lien of BK Asset Management

DailyFX provides forex news and technical analysis on the trends that influence the global currency markets.

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