3 Central Bank Acts: RBA, BoE, ECB

Last updated 2/2/2009 6:38 PM ET (GMT -5) 0 Comments - Add your comment

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Kathy Lien

Director of Currency Research, GFT

There are 3 interest rate decisions on the calendar this week from Australia, the United Kingdom and the Eurozone.  Only 2 out of the 3 countries are expected to cut interest rates but all 3 rate decisions and the corresponding comments from central bank officials should trigger some volatility in the currency market.  Although the amount of easing is important, what will receive more attention are the comments on how much further these central banks could cut interest rates. The upcoming rate cut is not expected to be the last for the Reserve Bank of Australia or the Bank of England and the expectation of further rate cuts could prevent a major recovery in the Australian dollar and British pound.

With that in mind, let us take a closer look at the 3 Central Bank Acts that are expected this week:

ACT 1:  AUSTRALIA

3 Choices for the Reserve Bank of Australia – 75bp, 100bp or 125bp

Compared to other G10 nations, the slowdown in the Australia’s economy has not been as deep. Of the eight major central banks, Australia currently has the highest interest rate. This evening, the RBA will be faced with the tough decision of cutting interest rates once again. The market is currently looking at an aggressive 100bp rate cut which would match their last rate cut in size. Like the Reserve Bank of New Zealand, Australia has been late to cutting interest rates and they are making up for it now. In 2008, they cut interest rates by 300bp in 4 months. Tomorrow, rates are expected to fall to a five decade low of 3.25 percent. The concerns affecting Australia are mainly growth related. The sheer inexistence of viable trading partners and declines in commodity prices has altered growth prospects severely to the downside. Former RBA Governor Bernie Fraser has not been quiet in his predictions for an overwhelmingly deep and long-lasting Australian recession. To add some validity to his forecasts, Consumer Confidence, the Unemployment Rate, Value of Loans, Retail Sales and Trade Balance have all suffered in recent months. In addition to an economically crippling narrowed trade balance, the country is now dealing with a Federal Budget Deficit as a result of the increased spending on economic stimulus. Only the NAB Business Confidence and the Employment Change managed to post improving results.

However a full percentage rate cut is not a done deal. The Australian dollar has been weak which is boosting inflationary pressures and that may push the RBA to consider a smaller 75bp rate cut. If they under deliver, it should be positive for the Australian dollar.   On other hand, the central bank of New Zealand shocked the markets by cutting interest rates 150bp. If the RBA wants to be aggressive and ahead of the curve, they could also follow in the RBNZ’s footsteps with a 125bp rate which would be bearish for the Aussie.   Unlike the US, Japan, Switzerland and even the Bank of England, the RBA is not running out of room to cut interest rates. Therefore keep an eye on the comments from the central bank following the rate decision.  Talk of continued rate cuts could drive the Australian dollar lower.   

ACT 2: UNITED KINGDOM

Bank of England: Headed to ZIRP?

The question that the market will be looking for the answer to from the Bank of England on Thursday is whether interest rates are headed to US levels. The Bank of England and the UK government as a whole has thrown everything including the kitchen sink at their economy and so far, they have nothing to show for it. Therefore since the BoE still has room to cut interest rates, they are fully expected to utilize this monetary policy instrument. A 50bp rate cut would take UK interest rates down to 1 percent, the lowest level ever for the central bank. Since September of 2008, the BoE has had no reservations about taking interest rates from 5 percent to 1.50 percent. The next interest rate cut will bring UK rates closer to zero, which will leave many people wonder, What Next? The BoE is operating in unchartered territory, and the GBP/USD is responding with its continued descent.  It will be interesting to see if the UK government starts talking about quantitative or credit easing after their monetary policy decision.

Other than restricted credit conditions, other economic reports seem to show a very slight improvement. Net Lending and Mortgage Approvals rebounded while retail sales increased in the month of December. However, GDP, CPI, and Consumer Confidence continue to wane. Even though CPI is at relatively high levels, it continues to fall as a more deflationary atmosphere takes hold. The developments in the credit markets are very much responsible for any dissatisfied consumers and perhaps a portion of the slowdown in GDP. While rate cuts may continue into March, they could get smaller and smaller.

While the urgency and brevity the BoE has acted is undeniable, the effects of their efforts do not seem too reassuring. Problem number one for the UK going forward is the fact that mortgage and other lending rates have resisted the downward pressures. This resistance severely reduces any positive effect the rate cuts were supposed to have on the economy. Without the ability to obtain credit, business and consumers alike will continue to postpone investments and spending until financing becomes available. This unfortunate clash of interests is what will keep the UK in a recession. Efforts have continued over the last month to provide lending institutions with the security required to restore normal credit conditions. In addition to securing and guaranteeing balance sheet items, the government has successfully negotiated the reduced ability of banks to raise their interest rate on loans. This month finally produced some reassuring reports in the form of Mortgage Approvals and Net Lending. However, the threat that credit markets pose has by no means alleviated. It has been shown that any increase in loans is in the form of very small debt obligations. Therefore, the BoE’s focus will have to be entirely on restoring the confidence among banks. While rate cuts are a very likely possibility, their success is doubtful. It is possible that the central bank may have to continue purchasing troubled assets and other toxic securities that are currently plaguing the financial system. This may be the defining factor of continued BoE policies.

ACT 3: EUROZONE

ECB to Keep Rates on Hold

After cutting interest rates by 225bp, the European Central Bank is expected to leave interest rates unchanged at 2 percent on Thursday.  The prospect of a monetary meeting that leaves rates alone seems almost abnormal these days. We have gotten so used to these massive all-out efforts to see rates go to zero that the idea of no cut may be psychologically worrisome to some traders. The fact of the matter is Trichet has not been quiet about his preference to keep rates remain steady. The ECB President feels obligated to allow the latest string of action time to work its way through the economy. However, up until now, the concerns over a worsening economic environment has not permitted the ECB head the privilege of time. It is undeniable that economic conditions since the last meeting have not made any discernable efforts at improving. However, there are certain bright spots that may allow Trichet the breathing room to resist further cuts. This month has seen, along with some truly devastating figures, a pickup in German IFO, German ZEW, and the Euro-Zone PMI composite.

After the last monetary policy decision in January, ECB President Trichet signaled to the market that 3 weeks is too short of a time to deliver another rate cut and therefore March will be the next meaningful meeting. Unlike other central banks, the ECB has not been extremely aggressive with easing monetary policy and has instead tried to defer rate cuts as much as possible. Even though interest rates in the Eurozone are already at historically low levels, Trichet is still expected to cut interest rates further. The rate decision itself should be a nonevent which leaves Trichet’s post meeting press conference as the main focus. Traders will be looking for clues on how aggressive the ECB will be in March. 

Concerns over economic growth still dominate in individual European countries. Despite the fact that some data surprised to the upside they are only small advances off of multi-year lows. Among the reports that may warrant a bit more concern is the severe shifts in EZ and German Unemployment. Even though Trichet has expressed the notion that the risks of deflation are negligible at this point, the overwhelming decline in CPI proves to be relevant. In addition, there have been the unprecedented measures that resulted in downgrades of some member countries, including Spain, Portugal and Greece. Others were left with warnings that their credit ratings were at risk. The higher costs of borrowing that accompany the rating cuts may provide reason for the ECB to continue cutting interest rates. 

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About The Author

Kathy Lien began her FX trading career 10 years ago at J.P. Morgan Chase. After graduating New York University’s Leonard Stern School of Business at the age of 18, Kathy joined the bank's interbank FX trading desk and eventually moved to the cross markets proprietary trading desk. In the interbank market, her ability to create solid fundamental and technical analysis from the myriad of information on the market helped her trade forex spot and options. Her experience eventually led her to be chief strategist at Daily FX where she worked until she joined GFT in 2008.

With her knowledge of forex, as well as her experience trading other products, such as interest rate derivates, bonds, equities, and futures, Lien has built a reputation as an international currency analyst. She is frequently quoted on CNBC, Bloomberg, Fox Business and Reuters. Lien has also written for publications like Active Trader, Futures, and SFO magazine. She is the author of the newly updated Day Trading the Currency Market: Technical and Fundamental Strategies to Profit from Market Moves, and the co-author of Millionaire Traders: How Everyday People Are Beating Wall Street at Its Own Game with Boris Schlossberg.

To buy Kathy’s newly updated Day Trading and Swing Trading the Currency Market: Technical and Fundamental Strategies to Profit from Market Moves, click here.