The Reserve Bank of Australia meets tonight and new central bank governor is at the helm. Phillip Lowe, former RBA deputy governor succeeded Glenn Stevens and investors will be paying close attention to the new governor’s tone. Chances are he is going to play it safe and maintain the central bank’s upbeat outlook. The last time they convened they expressed confidence in the trend of growth and labor market. When Lowe spoke last month, he said the labor market is not as strong as the unemployment rate suggests and inflation is expected to remain low for some time. Taking a look at the table below, there has been as much improvement as deterioration in Australia’s economy since the last monetary policy meeting with broad improvements in China. So while RBA Governor Lowe may be optimistic, the main takeaway will be patience. AUD may fall on this but at a time when the central banks of the U.K., Eurozone, Japan and New Zealand are considering more stimulus, a neutral bias will make any declines shallow. In fact we believe the better trade is to be long AUD pre-RBA.
The European Central Bank’s monetary policy announcement is the most important event risk on the calendar this week. Aside from the rate decision, the central bank also releases its latest economic projections which helps to shape future policy plans. ECB President Draghi is expected to remind investors that inflation is low, the economy is weak and easier monetary policy may be needed. Consumer spending has been particularly soft, manufacturing and trade activity took a hit after Brexit and most importantly, inflation remains well below target with year over year core CPI growth slipping to 0.8% from 0.9% in August. However there have also been areas of improvement namely in business confidence, German spending and German stocks. Some are hoping for more QE but at most we expect the ECB to extend its asset purchase program beyond March 2017.
As usual the EUR/USD there will be different phases to the currency pair’s post ECB reaction. First, if there is no new QE, EUR/USD will jump. Then the second and more sustained reaction of the day will depend on the ECB’s guidance and their staff forecasts – most likely these will be dovish which means weakness for the euro. However if there is no QE and Draghi stresses that they are in wait and see mode, the gains in EUR/USD will be sustained and of course if there is new QE, EUR/USD will drop to 1.11.
Here’s a look at how Canada’s economy changed since the last Bank of Canada meeting. Definitely more weakness than strength which means BoC could be more dovish
Tomorrow’s Bank of England meeting is one of the most important events this month. Back in July, U.K. policymakers made their plans to ease in August abundantly clear and now that the time has come, sterling has been surprisingly stable. By giving investors sufficient warning, the market had the opportunity to completely discount a 25bp rate cut and the question now is if the BoE will do more. They could cut interest rates by 50bp or they could combine a quarter point cut with renewed bond buying. Quantitative Easing was a critical part of the BoE’s monetary policy during the financial crisis but with interest rates already so low, the effectiveness of QE is in question. Many economists believe they will revive the program but not this week. Since Britain decided to leave the European Union, the Bank of England has taken major steps to stabilize the financial markets and encourage lending – and so far it has worked! Stocks are stable, yields have increased and the doomsday sentiment in the market is fading. A lot of this has to do with the U.K. government’s decision to postpone invoking Article 50 for the next year or two, reducing the immediate risk for businesses. This means the central bank can wait to ease again when there is a greater evidence of a deep contraction in the economy.
Taking a look at the table above, there’s certainly been more deterioration than improvement in the U.K. economy since the July monetary policy meeting. However wages are up, the unemployment rate is down and consumer prices are ticking higher. Second quarter GDP growth was also better than expected. Although manufacturing, services and the composite PMI indices fell sharply in July, this morning’s numbers were not revised lower after the flash release. When the Bank of England releases their Quarterly Inflation Report tomorrow, their forecasts will be grim – policymakers previously warned of a possible recession post Brexit. Governor Mark Carney won’t have anything positive to say outside of acknowledging financial market stabilization. Yet economic and financial conditions are not desperate enough for the Bank of England to rekindle their QE program.
In other words, we feel that the Bank of England doesn’t need to send a strong message to the market right now outside of a 25bp rate cut and a stern warning of more easing in the coming months. If we are right, we could see a bigger short squeeze in GBP/USD that will allow investors to reset their short positions at higher levels. The U.K. is not out of the woods, as growth will only slow further in the coming months / years because the U.K. government is simply delaying the inevitable. If they cut by 50bp or restart their bond buying program, sterling will fall quickly and aggressively.