GBP/EUR 1.1990 (0.8340)
We mentioned yesterday the ECB carried the greatest potential to surprise in yesterday’s event risk and we were not disappointed. The ECB cut the benchmark interest rate to .25%, a fresh record low, although they left the deposit rate at 0%. The Bank of England release proved to be a dull affair, no change announced and no policy statement to give us insight into the meeting. US GDP beat expectations growing 2.8% in the third quarter, better than the 2% expected and even better than the 2.5% in Q2.
As discussed the ECB caught most of the market off guard by cutting their benchmark interest rate by .25%. There is no question that there was a dovish tone entering the meeting following last week’s weak inflation readings and poor unemployment figures, we have been warning of this risk for several months as the regions recovery was too slow. Calls by Italy for the ECB to act and an overvalued euro putting pressures on growth also all meant the ECB had a lot on their hands. Most however, including us, expected the ECB to give indications as to when they would act but it was always going to be a close call.
We have to question the effect of such a rate cut, as a headline it is encouraging but with rates so close to zero, the benefits for further rate cuts are questionable and in other developed nations who have done similar in the past have yielded little in terms of growth (see the US). Draghi has proven he is not afraid to act and yesterday’s shock and awe tactics in our view were just that.
The ECB also promised to offer as much liquidity to banks as they need over the next year and a half. This form of verbal intervention has served Draghi well in the past and certainly acts to support the European financial system but the issue is beyond the banks and with credit growth remaining subdued, low interest rates are of no benefit if the loans required to grow are not forthcoming. The ECB balance sheet continues to contract as the LTRO is repaid, should we see inflation continue to fall then we would not be surprised the see the ECB take further steps over the next two quarters.
The pound was stronger on the whole yesterday despite GBPUSD dropping on the ECB release and stronger than expected US GDP but it soon recovered its lost ground. In a market poised for bad news no news can be good news and that seems to be the case with GBP, especially when it’s closest trading counterpart is coming under selling pressure. The BOE kept rates at .50% and held their asset purchase target at £375 bln. The strength of the UK economy has seen it benefit from regional flows as the outlook for the Eurozone deteriorates.
The USD rallied as data pointed towards a stronger third quarter than expected, growth of 2.8% on an annualised basis is very encouraging for the world’s largest economy but more importantly its adds some weight behind our expectations that taper may in fact begin earlier than late Q1 2014. Despite the rise in GDP there was a marginal decline in personal consumptions and core consumption expenditure. The Fed would likely want to see these metrics pick up ahead of looking to scale back their current QE policy.
Today’s Non Farm payrolls will be the key indicator for tapering expectations. The NFP figures released today will reflect the shutdown period in the US and even after the FOMC refused to soften their taper talk towards the end of October any sign of weakness on the jobs front will be negative for the USD. Expectations are for 120k jobs to be added during the period with the unemployment rate to tick higher to 7.3% from 7.2%. Anything weaker will see heavy USD selling and most likely send US equities to fresh highs but our risks for an aggressive move are if data is better than expected.
Elsewhere this morning France received another downgrade from S&P to AA with outlook negative. The Euro was relatively un-changed on this news and remains mixed today.