FOREX TRADING

ECB Meeting: Heading for the Exit

• The ECB is now heading for the exit. For one thing they are cutting down on the longer term auctions. The 12-month auction in December will be the last of its kind and so will the 6-month auction at end-March. This is slightly more hawkish than expected.
• Markets were particularly surprised by the ECB moving away from 1% at the 12-month auction and instead applying a rate calculated as the average minimum bid rate of the weekly main refinancing operations over 12 months. Consensus expectation was a flat 1%.
• Trichet was eager to say that this was not intended as a signal of future rate hikes, but it is nevertheless likely to be interpreted as an indication that the ECB considers hikes in 2010 likely. The procedure might help to curb banks’ demand at the auction without affecting interest rate expectations as much as a fixed spread would have.
• The weekly main refinancing operations and the 1-month and 3-month auctions will be with full allotment at least until early April. We find it likely that the ECB moves away from full allotment at the 1-month and 3-month auctions in April.
• The ECB’s assessment of the economic situation is becoming more positive. Nevertheless we still consider that the ECB is too downbeat. We think that they could double their growth forecast for 2010 and still turn out to be too dovish.
• The ECB expects inflationary pressures to be low. But in their inflation projection, the upper end of their band for 2011 is nevertheless 2.0%. They will not have to revise their inflation expectations much upward before they can defend moving away from record low interest rates.
• Today’s press conference has been slightly more hawkish than we expected. It has clearly surprised some observers how determined the ECB is to move towards the exit. Nevertheless market reactions were muted – with interest rates rising ahead of the meeting on rumours that the ECB would be hawkish.

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Preview of Thursday’s BOE & ECB meetings

The Bank of England (BOE) will hold a policy meeting on Thursday November 5th. At the October policy meeting the BOE elected to maintain the current level of interest rates at a record low 0.5% and asset purchases at £175bln. The BOE indicated that they would keep the scale of the asset purchase plan under review. Two recent UK economic reports generated concern about the outlook for the UK economy and may encourage the BOE to expand its asset purchase plan at the November policy meeting. UK Q3 GDP posted an unexpected 0.4% decline.

The trade had expected a rise of 0.2% for Q3 GDP. The decline in GDP suggests that the BOE asset purchase plan has yet to boost the UK economy out of recession. UK manufacturing output fell by 1.8% in August. The decline in manufacturing output adds additional doubt about the UK economic recovery. The BOE must also take in consideration today’s report of continued UK bank troubles. The UK government announced Tuesday that it will take a bigger stake in RBS and Lloyds Bank. It is not clear if he BOE will hold its asset purchase plan unchanged or elect to expand the purchase plan by £25bln or £50bln at Thursday’s policy meeting. Today’s Wall Street Journal reports that a majority of economists expect the BOE to hold policy steady and expand its asset purchase plan by £25bln. Based on the UK Q3 GDP report it may be difficult for the BOE to refrain from adding additional stimulus. Recent GBP price action has found that the GBP benefits from BOE decision to hold the level of asset purchases and weakens when the BOE elects to expand quantitative ease. Monday, the BOE’s Blanchflower said that the BOE may expand its asset purchase program by another £50bln. The Sunday Times however carried a piece warning the BOE not to panic over the Q3 GDP report. GDP is seen as a lagging indicator.

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