Sunday, March 1, 2009

FX Briefing : ECB - Half-Hearted Interest Rate Cut


  • Japanese slide accelerates, yen drops
  • ISM and US payroll data continue to deteriorate
  • ECB set to cut interest rates to 1.5%
EUR-USD rallied initially, but relinquished its gains again later in the week. At the beginning of the week, the euro shot up towards 1.30 on rumours about the possible nationalisation of US banks. However, after equity markets collapsed - on Monday afternoon, the Dax fell below 4000 - it tumbled to around 1.28. Finally, on Friday, EUR-USD dropped below 1.27, thus ending the week at about the same level as the previous week. After dropping sharply in the last few weeks, most eastern European currencies recovered again somewhat. The central banks of Poland, the Czech Republic, Hungary and Romania issued a joint statement criticizing the recent selloff as exaggerated and announcing that they were prepared to take coordinated action. This seemed to have some impact on market participants.

Whereas the euro held its ground quite well this week, the Japanese yen (and all the other Asian currencies) remained under significant pressure. The extremely weak trade balance figures for January and the fact that industrial production declined again by 10% month-on-month confirmed fears that the downturn in economic activity would actually accelerate in the first quarter. Against this backdrop, USD-JPY rose temporarily to 98.71, only to slip back to around 97.30 on profit-taking and rumours of exporters' dollar sales.

The relative strength of the euro cannot be put down to economic data alone. The European figures were mixed. The EU Commission's Economic Sentiment Indicator for the Eurozone continued its downward trend and is now at 65.4% of its long-term average. The outlook for the industrial sector seems to be particularly gloomy, whereas a few of the consumer and retail trade indicators were slightly more upbeat: French consumer spending in January, for example, as well as the ifo business climate index for the retail trade for February and the German GfK consumer climate.

Over the last few months, bad US data have tended to have an impact on the euro too. And there were plenty of them: consumer confidence plummeted to a new record low, new and existing home sales collapsed by over 10% and over 5% respectively in January. Durable goods orders fell by 5.2% in January, and the previous month was revised down to -4.6%. Even excluding transportation, the decline in the last two months comes to about 8%. Moreover, initial jobless claims rose to 667,000, the highest level for 27 years. Thus it looks very much as though the ISM Survey and the labour market report, both due to be published next week, will be very weak. Fed Chairman Ben Bernanke‘s Monetary Policy Report to the Congress was the only glimmer of hope. Mr Bernanke expressed the hope (which had already been formulated in the minutes of last week) that the economy could stabilise towards the middle of the year. However, this prediction was hedged around with numerous “ifs” and “buts”.

Maybe the fact that the euro was relatively robust this week can be taken as a sign of cautious optimism. But, given that equity markets plummeted to new record lows this week, that is not all that plausible. In our view, the euro is more likely to have been boosted by the weakness of the yen and the calming down (presumably only temporarily) of the eastern European currencies.

In addition to the US data (ISM, labour market report), market participants will be focusing primarily on the ECB governing council meeting. Markets are expecting interest rates to be cut by 50 bp to 1.50% on Thursday, and ECB representatives have basically supported this notion. It is also relatively clear that the ECB will acknowledge that there is further scope for interest rate cuts. Bundesbank president Axel Weber, for instance, stated last week that he sees a refinancing rate of 1% as the lowest limit. There is scope down to that level.

It is not clear, however, how the ECB will explain its decision. We suspect that the governing council could, yet again, succumb to the temptation of raising hopes of an economic recovery during the course of the year, warning about medium- term inflation risks and philosophising about exit strategies from the expansive monetary policy. We are assuming that the growth projection for 2009 will be around -1.8%, which suggests that a recovery is expected in the second half of the year. ECB staff's inflation projections could be around 0.8% for 2009 and 1.6% for 2010; this would be more or less in line with the medium-term stability target. With this relatively mild scenario in mind, the ECB could decide to thwart expectations of further interest rate cuts.

A hawkish ECB could strengthen the euro initially, as the European yield curve could steepen and the interest rate advantage over the USA increase. However, during the course of the financial and economic crisis, the ECB's signals have become less significant: markets have now got used to the ECB being behind the curve. This would limit the positive impact on the euro. Furthermore, there is the worry that procrastination could exacerbate the problem.


This report has been prepared by BHF-BANK Aktiengesellschaft on behalf of itself and its affiliated companies (together "BHFBANK Group") solely for the information of its clients.

The information and opinions in this document are based on sources believed to be reliable and acting in good faith, but no representation or warranty, express or implied, is made by any member of the BHF-BANK Group as to their accuracy, completeness or correctness. Opinions and recommendations are given in good faith but without legal responsibility and are subject to change without notice. The information does not constitute advice or personal recommendation, for which the duty of suitability would be owed, but may facilitate your own investment decision. Moreover, you should seek your own advice as to the suitability of an investment matter mentioned herein. Investors are reminded that the price of securities and the income from them can go down as well as up and that the past performance of an investment or a market is not necessarily indicative for future results.

This document is for information purposes only. Descriptions of any company or companies or their securities mentioned herein are not intended to be complete, and this document is not, and should not be construed as, an offer to sell or solicitation of any offer to buy the securities mentioned in it. BHF-BANK Group and its officers and employees may have a long or short position or engage in transactions in any of the securities mentioned in this document, or in any related securities.