No need for further action from the ECB.... for now

The ECB have decided to keep interest rates on hold for yet another month despite concerns that the euro area may slip into deflation. The last inflation reading provided upside surprise and the central bank’s projections show they expect inflation to increase only slightly this year to 1%, to 1.3% in 2015 and 1.5% in 2016. Therefore, the ECB’s medium to long term projections of inflation still remain well anchored and predict inflation will be slightly below the 2% in the fourth quarter of 2016. The ECB remain ready to act however considering the governing council see their “baseline by and large confirmed”, the likelihood of further easing has been reduced.

Taking into account the euros strength over the past few months, it is worth noting that ECB President Draghi estimated that inflation had be reduced by roughly 0.4 or 0.5 percentage points due to the strength of the single currency. Nevertheless this has not discouraged the market from buying euros pulling the GBPEUR rate below 1.21, and EURUSD through 1.3830.

Sasha Nugent

Currency Analyst 

Caxton FX

A confidence booster for the BoE

After the last flagship forward guidance from the BoE undermined the credibility of forecasts and expectations, things seem to be getting off to a better start for the central bank. For the first time since November 2009, inflation has dropped marginally below the inflation target to 1.9%, further justifying the need to keep interest rate at current levels.

In the quarterly Inflation Report released last week, the bank predicted inflation would fall below the 2% target and expect lower levels to remain for a while to come. A combination of lower inflation and a decent recovery creates an environment which will allow the BoE to continue to maintain their accommodative stance, and further support the recovery.

There is also a hope that as the recovery gathers momentum, lower price pressures will reflect into rising real wages as pay increases outpace inflation, therefore restoring purchasing power. The next key release will be tomorrow’s unemployment figures and although a drop in unemployment would be positive, the focus will be on wage growth.

For now BoE forward guidance remains credible, however with the market still set on a rate increase in 2015, investors may need a little more convincing that interest rates will remain low for a while yet.

Sasha Nugent

Currency Analyst

Caxton FX

No action from the ECB for now

The euro has been given a boost from less dovish remarks by ECB President Draghi, following the rate announcement which saw the central bank keep interest rates unchanged at 0.25%. The language was fairly unchanged considering what we have heard from the ECB in the last few months, however the unexpected dip in inflation had the market anticipating a more negative statement.

Draghi continued to emphasize the central banks focus on its medium to long term inflation expectations, claiming that more information is needed for the ECB to take action. The slip in inflation back to 0.7% y/y hardly affected the central bank’s stance and despite prolonged low inflation being a risk within itself, Mr Draghi said “We are alert to these risks and we stand ready and willing to act”.

There has been a grey area over what tools in particular the central bank stand ready to deploy. Some analysts thought the ECB could stop absorbing the euros created from its Securities Markets Programme. Although Mr Draghi claimed that this was one of the options being investigated, he also highlighted that there are other instruments being considered.

So where does the ECB stand now? In the same position it did before. The governing council require more information before deciding on whether to act, and “expect key interest rates to remain at present or lower levels for an extended period of time”. With Mr Draghi insisting the ECB does not see deflation in the eurozone, it is no surprise that the market took this as an opportunity to buy some more euros.

Sasha Nugent

Currency Analyst

Caxton FX

Emerging market central banks rush to curb rapid currency depreciation

In the last 48 hours we have seen emerging market central banks take bold decisions in order to curb severe currency weakening as turmoil in emerging markets strengthened, and investors rush towards safe haven currencies. The Reserve Bank of India was the first to get the ball rolling in a surprise move raising interest rates by 25 basis points to 8%, in a bid to fight back against inflationary pressures.

The Turkish Lira was one of the worst affected currencies as political concerns also weighed on the currency. In an emergency meeting the Turkish central bank raised all the main interest rates, in an attempt to stabilise the currency. The overnight lending rate rose to 12% from 7.75%, the overnight borrowing rate rose to 8% from 3.5% and the one week repo rate increased to 10% from 4.5%.

The South African Reserve Bank also followed suit as the nation battles with labour disputes. The bank raised its borrowing rates by 50 basis points to 5.5% in spite of the fact that inflation remains with the central bank’s target range of 3%-6%.

Despite all these efforts to prevent further currency weakness, any gains after each announcement were soon erased. The market seems to be unimpressed by central bank’s attempts to convince the markets they are ready and willing to take action. Turkey’s central bank’s move could be described as delayed, and although the SARB rate increase was unexpected, it failed to grab investors’ attention. What the market needs is to be convinced that these central banks are completely committed and engaged in consistent aggressive policy in order to ensure not just a stable currency, but also price stability.

Sasha Nugent

Currency Analyst 

Caxton FX

Bank of Canada deals the loonie a blow

The Bank of Canada is ahead of almost every other developed nation central bank in terms of when it expects to normalise monetary policy (raise interest rates). The fact that it is even discussing it is your first clue, as conversations within central banks such as the Bank of England, Reserve Bank of Australia, the European Central Bank and the Riskbank are slanted towards rate cuts, not rate hikes. If it’s not rate cuts, then it’s more QE from the likes of the US Federal Reserve and the Bank of Japan, whose base rates are already at rock bottom levels.

Last year’s Bank of Canada rhetoric pointed towards a rate hike this year. However, the slowdown seen in the US at the end of 2012 has contributed to softer growth in its northern neighbour. Canadian growth has consistently surprised the BoC to the downside in the past year, particularly in the second half of 2012. Governor Carney (BoE-bound this summer) & Co yesterday indicated that the Canadian economy will not be up to full capacity until the second half of next year, which is a major delay compared to the previous ‘late 2013’ projection. Combined with subdued inflation and ongoing concerns over household imbalances, this has led the BoC to communicate that a rate hike is by no means imminent. It estimates a rate hike at the end of this year but our bet is that it will come a later than that.

The loonie has taken a hit as a result of the BoC’s change of position. GBP/CAD climbed by more than a cent and a half up to 1.5850, where it currently trades. Meanwhile CAD/USD dipped by a cent to a level just below parity, which represents a two-month low. This is a bit of a knock to the loonie but we do expect the currency to outperform GBP in the coming months, with another move down to 1.55 very much on the cards. 

Richard Driver

Currency Analyst

Caxton FX

Japan’s earthquakes (Kobe 1994 and Tohoku 2011): the effect on yen

One month on from the Japanese natural disaster on March 11th, we saw this as an interesting opportunity to compare the currency market’s response with the earthquake that struck back in 1994.

On January 17th 1994, a 7.3 magnitude earthquake hit Kobe; killing over six thousand people and causing ten trillion yen worth of damage (amounting to roughly 2.5% of Japanese GDP). The yen proceeded to strengthen by 18% against the US dollar in the space of three months, before almost halving in value in the subsequent three years.

So how does this compare to yen’s response to this most recent disaster?

The Japanese currency did appreciate, but only by 5% against the greenback and in the space of just 5 days. This climb was reversed within the following five days as the world’s G7 Central Banks intervened to curb further yen appreciation. Since that date the yen has continued to steadily lose value as the market picks up on the lower growth potential and the expectation of rock bottom interest rates in Japan for some time to come. Indeed the yen is currently down at a 7-month low with further room to drop.

The natural market response (yen investment) in the wake of last month’s earthquake was cut well short by the unprecedented and prompt Central Bank intervention. In the current climate, the Bank of Japan is simply unwilling to allow its already weak economy to suffer the serious knock to its exports that a stronger yen would amount to. Obviously we are yet to find out whether the yen will devalue to the same extent as in the late 1990s, but the current forecast is for continued depreciation on the basis of weak fundamentals.

The USD/JPY rate currently sits at 85 yen. Forecasts 12 months out expect to see the US dollar reach 100, but the 144 level reached in 1998 does at this point seem very far-fetched, particularly as the Fed are hardly in a hurry to tighten monetary policy either.

Richard Driver
Analyst – Caxton FX


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