Pound and Euro Forecast

Today, the Bank of England and the European Central Bank will each announce their monetary policy decisions. Expectations are for both banks to leave rates steady, but given the steep declines we’ve seen in the Euro and British pound recently, even decisions in line with expectations could lead the currencies to rebound. The question is: will these moves be in the form of significant rallies, or will the gains be short-lived?

Bank of England – Risks Tilted Toward Additional Rate Cuts This Year

Bias for This Meeting: No Change
The Bank of England is expected to leave rates steady on Thursday at 5.00 percent – the lowest since December 2006 – for the fourth consecutive month. Indeed, all of the 60 economists polled by Bloomberg News anticipate such a decision. The rate announcement will come at 7:00 EDT but since the Monetary Policy Committee is anticipated to leave rates unchanged, they are unlikely to issue a monetary policy statement which should leave the market’s reaction to the news somewhat muted.

What are the fundamental factors that the MPC will be taking into account? Inflation pressures in the UK have built up significantly on the back of rocketing commodity prices, as CPI jumped to an annualized pace of 3.8 percent in June. Furthermore, the latest BRC Shop Price numbers for July suggest that consumer price growth accelerated even more. Rising costs are weighing heavily on consumer sentiment, especially as jobless claims jump and home prices continue to freefall. This has translated into lackluster retail sales, which plunged 3.9 percent in June alone, and a contraction in service sector business activity for the third consecutive month. Likewise, the July PMI reading for the manufacturing sector also reflected contraction for the third month in a row, while output has fallen negative in five of the past seven months. The persistent gains in measures of consumer prices should keep the Bank of England’s MPC concerned about inflation risks, but perpetual doves like David Blanchflower are sure to focus more on potential for a UK recession.

How will the Markets Respond to the News? Currently, overnight index swaps are pricing in almost 50bps worth of rate cuts within the next 12 months, which is part of the reason why the British pound has taken such a heavy hit versus the US dollar in recent weeks. However, once traders see that the Bank of England has chosen to, in fact, leave the Bank Rate unchanged at this meeting, the markets may reduce those rate cut expectations. Thus, there is potential for GBP/USD to rise on Thursday. On the other hand, if the Bank of England unexpectedly decreases the Bank Rate to 4.75 percent, or surprisingly publishes a Monetary Policy Statement that focuses on dour credit conditions and downside risks to growth, speculation of additional rate cuts will surely mount and weigh heavily on the British pound. Nevertheless, the odds of this happening are very slim, and as a result, we hold a bullish bias for the British pound on Thursday.


European Central Bank – Will Mr. Trichet Finally Cool Down His Hawkish Rhetoric?

Bias for this Meeting: No Change
Like the Bank of England, the European Central Bank is widely expected to leave rates steady at 4.25 percent after hiking by 25bps in July. The rate announcement will come at 7:45 EDT, but the big show is at 8:30 EDT when ECB President Jean-Claude Trichet will give his monthly press conference. Will he remain hawkish, or focus more on the slowdown in the economies that compose the Euro-zone? Estimates for Euro-zone CPI in July jumped to a fresh 16-year high of 4.1 percent from 4.0 percent, which is well above the ECB’s 2 percent target as energy and food costs remain high. Furthermore, the Bank of Spain said last week that “upside risks for inflation in the Euro-zone are high.” As a result, there’s little doubt “price stability” will be the foremost concern for Mr. Trichet.

How will the Markets Respond to the News?
Where we see there being risk for the euro is in Mr. Trichet’s comments on growth. While he was fairly clear in stating that there were significant downside risks to growth during his monthly press conference in July, he maintained that growth was “moderate” and “ongoing.” However, conditions have deteriorated quite a bit since then, especially for consumers. In fact, the annual rate of Euro-zone retail sales growth fell to a record low of -3.1 percent in June, as the unemployment rate unexpectedly rose to 7.3 percent from 7.2 percent. Meanwhile, July PMI reports for both the services and manufacturing sectors signaled a contraction in business activity for the second months in a row. While this does not put the ECB at risk of cutting rates given the fact that they only have one primary mandate of maintaining price stability, Mr. Trichet may be more inclined to admit the deterioration in the economy during his 8:30 EDT press conference on Thursday.

Currently, overnight index swaps are pricing in a very small chance of a rate cut within the next 12 months, but the recent moves in EUR/USD have more to do with the fact that traders are also pricing in rate increases by the Federal Reserve during the same period. Yet, if Mr. Trichet’s commentary is hawkish enough to convince the markets that they have no intention of reducing rates anytime soon, the euro is likely to subsequently gain. However, it may take particularly strong words to ignite a significant rally for the currency, such as references to the ECB being in a state of “heightened alertness.” On the flip side, if Mr. Trichet focuses more on monetary policy being appropriately accommodative, suggests that inflation pressures could ease in coming months, or sounds significantly more bearish on the Euro-zone economy, EUR/USD could continue to fall. Our bias for Thursday? EUR/USD could rally on Mr. Trichet’s comments, but the gains may be short-lived.