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FX Briefing - Decision days

FX Briefing 29 October 2010





Uncertainty still prevails over Fed asset purchase programme

Democrats set to lose majority in House of Representatives

BoJ speeds up launch of 35 trillion package, moves policy meeting forward

Strong Q3 growth in UK eases pressure on BoE to act

ECB likely to leave monetary policy unchanged and continue towards normalization


Decision days


Since the beginning of October, EUR-USD has been oscillating around 1.39, alternately dropping below 1.38 and then rallying to above 1.40 again. The movement was generally triggered by speculation on the likelihood of the Fed launching further quantitative easing measures and, particularly in the last few days, the volume and timescale of these


The crucial FOMC meeting is drawing closer: the Fed is expected to unveil its plans on Wednesday evening. Although a further economic downswing – a double dip – seems unlikely at the moment, the question of “whether” to launch QE2 appears to be a foregone conclusion despite opposition within the FOMC. The question of “how much” still remains open. According to an article in the Wall Street Journal at the beginning of the week, the Fed is likely to announce an asset purchase programme of “a few hundred billion dollars over several months”. Furthermore, the article suggested that the Fed would take a “gradual approach”, and also mentioned that some economists and FOMC members had expressed doubts as to the wisdom of a bond buying programme.


The WSJ article suggests that the Fed is more likely to act cautiously – a view which we share and which is in line with recent economic data. This week’s data showed an improvement in consumer confidence, for example, an unexpected unexpected sharp rise in home sales, and a decline in initial jobless claims. GDP growth in the third quarter was 2.0% as expected. However, the PCE core deflator probably slipped to 1.2% at the end of the quarter, which appears to confirm the downward trend. Furthermore, the news that the New York Fed has been asking banks about their expectations of an asset purchase programme suggests that the Fed does not want to fall short of banks’ high expectations. The report was primarily responsible for lifting EUR-USD from its low of 1.3734 on Wednesday to over 1.39.


There were also other factors outside the US which weighed on the dollar. After its regular meeting, the BoJ announced some additional decisions on its 35 trillion yen QE programme.

The most important of these was the decision to buy CP with a rating of A-2 or higher and corporate bonds with a rating of BBB or higher (for a total of 1 trillion yen); up to now the lower limits had been A-1 and A respectively. The BoJ also stated that it was moving forward the date of the next policy meeting by 11 days to 4-5 November, apparently to speed up the launch of the programme and to enable it to react promptly to the Fed’s quantitative easing measures.


The weak economic data released on Thursday night might have made this decision easier. Industrial production plunged again in September by 1.9% compared with the previous month, the fourth drop in a row. It has thus fallen by 1.9% in the whole quarter too, which, together with a sharp decline in the trade surplus in Q3, does not bode well for GDP growth, especially as production is set to decline again in Q4.


The pound sterling celebrated a kind of comeback this week. After BoE governor Mervyn King had the previous week signalled that he was basically open to stepping up asset purchases, and the government’s spending cuts review had propelled EUR-GBP to over 0.89 – its highest level since April – the release of the preliminary GDP growth rate in Q3 reversed the movement. The UK economy grew by 0.8% quarter-onquarter – about twice as fast as expected. The pound was also boosted by the news that S&P had revised the UK’s AAA outlook from negative to stable.


Given that economic growth was better than expected and the inflation rate is relatively high, the Bank of England could decide to leave the asset purchase plan on hold for the time being. We are not expecting any changes in interest rates to be announced at next Thursday’s meeting, nor any additional asset purchases. However, the BoE will signal clearly that it is keeping its options open. Then, when the government’s massive savings cuts begin to bite next year, the appropriate action can be taken


The fourth major central bank holding its monetary policy meeting next week is, of course, the ECB. The ECB is probably the only central bank in this league with no inclination to easing measures. On the contrary: we are expecting the ECB to continue on the path to normalising monetary policy. It is unlikely to make any concrete decisions on this at its November meeting, however. Monetary policy stance is unlikely to change in Q4. Measures to be taken in Q1 (we are expecting the bank to revert to variable-rate tenders in January) is presumably under discussion and will probably be decided in December.


It is feasible, however, that the ECB will modify its assessment of the economic situation somewhat, to take account of the upbeat economic data over the last few weeks. Economic sentiment in the eurozone has improved significantly again in October, particularly in France and the Netherlands, but also in Germany (where the level is already quite high) and Italy. The manufacturing sector in particular reports growing order books and sees the production outlook in an even more favourable light. This suggests that the growth trend will continue into the fourth quarter. Furthermore, inflation seems to be getting gradually higher than the ECB’s last projection. During the winter months, the inflation rate could rise to 2.0% or even slightly higher.


The US Congress elections are taking place on 2 November. According to the polls, the Democrats will lose their majority in the House of Representatives; moreover, their majority in the Senate could also dwindle. Bigger spending programmes are hardly likely to be approved in the new constellation, which will be of particular interest to the markets. By the same token, the Republicans will not be able to halt the healthcare reform either, nor prevent the expiry of the Bush administration’s tax cuts.


Stephan Rieke +49 69 718-4114



Economics Department

+49 69 718-3642

[email protected]

Foreign Exchange Trading

[email protected]

Matthias Klein

+49 69 718-2175

Matthias Grabbe / Klaus Näfken

+49 69 718-2146 / -2683


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.


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