While most Americans are off enjoying their July 4th holiday, big moves are happening in the FX market. The euro and British pound dropped to 5 week lows against the U.S. dollar, taking out key levels in the process. The absence of U.S. traders most likely compounded the volatility in currencies. The European Central Bank and the Bank of England left monetary policy unchanged but Mario Draghi and Mark Carney made it clear that both central banks have a bias to ease. The dovish comments from European central bankers were motivated by the recent volatility in interest rates and a desire to set themselves apart from the Federal Reserve who is on a path to reduce stimulus. The ECB and the BoE wants everyone to know that they are still prepared to increase stimulus if the volatility in the bond markets persist or their economies weaken.
In the Eurozone in particular, the EUR/USD dropped through 1.30 and 1.29. The currency started to fall as soon as Draghi said that policy will remains accommodative as long as needed, there are downside risks to their economic outlook and rates will stay low for an extended period of time. The sell-off gained momentum when the central bank took the unprecedented step of forward guidance. The ECB said there is no exit in sight, they are keeping rates low for an extended period of time, their decision will be data dependent and they are keeping an open mind on negative deposit rates. Draghi also reminded everyone that the central bank is “technically ready” for negative rates. They had an extensive discussion about the possibility of a rate cut and unanimously decided that the guidance was needed which included saying that 50bp is not the lower bound. The central bank is screaming their bias to ease from the top of the mountain – they don’t want to leave any room for ambiguity because the risk could be a further rise in yields. Having dropped below 1.29, the next support for the EUR/USD should be at 1.28.
The British pound also fell sharply against the U.S. dollar following the Bank of England meeting. Even though the central bank left monetary policy unchanged, Mark Carney wasted no time in leaving his mark on the BoE. In the past, when no alterations are made, the accompanying statement contained nothing more than 2 sentences repeating current policy. However at his very first meeting as BoE Governor, Mark Carney adopted a tactic used by many other central banks including the Bank of Canada. Having just taken over a few days ago, no one expected Carney to use the statement to provide transparency and guidance so quickly. The BoE started the statement by expressing frustration with the recent rise in short term interest rates. While they felt that the economy is recovering, the pace is “weak by historical standards” and “a degree of slack is expected to persist for some time.” They also warned that, “significant upward movement in market interest rates would weigh on that outlook.” Consumer prices are expected to increase in the near term and the Bank of England did not feel that the path of the bank rate is warranted based on the trend of economic data. The British pound was crushed by these comments because right out of the gate, Mark Carney made a point to let the world know that he will be a more aggressive central banker with a dovish monetary policy stance and this bias could drive the GBP/USD to 1.50.