Will the BoE Quarterly Report Drive GBP to 1.70?

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Daily FX Market Roundup 05-13-14

Will BoE Quarterly Report Drive GBP to 1.70?

USD: No Tightening without Spending

EUR Extends Losses as Weaker ZEW Reinforces Need to Ease

AUD Shrugs Off Weaker Economic Reports

NZD Rebounds Ahead of Retail Sales Report

CAD: Comm Dollars Unfazed by Weaker Chinese Data

USD/JPY Could be Supported by Further Gain in Nikkei

Will BoE Quarterly Report Drive GBP to 1.70?

For the next 24 hours, everyone’s focus will shift to the British pound because the Bank of England’s Quarterly Inflation Report is the most important event risk this week. As shown in the following chart, the last time the report was released in February, GBP/USD jumped more than 150 pips in one day in a move that took the currency pair from a low of 1.6426 on the day of release to a high of 1.6822 three days later. At the time, the BoE surprised the market by upgrading their growth forecasts and dropping their 7% unemployment rate threshold. Back in November, we also saw a very strong rally in GBP/USD when the central bank upgraded their economic forecasts and said the unemployment rate could fall below 7% by the end of 2014. The day the Quarterly Report was released, GBP/USD jumped 200 pips and then gained a total of 450 pips over the next month. This month speculators are not only looking for continued optimism by the central bank but they also expect the BoE to signal plans to tighten monetary policy. In fact this speculation even sent the GBP/USD within a few pips of 1.70 this month. While profit taking at this key resistance level drove sterling off its highs, many traders believe that the currency pair could retest this level if the central bank suggests that rates could increase as early as this year.

So the big question before us is whether the economic landscape has changed enough for the central bank to take a more active approach to monetary policy and we think the risk is for a disappointment. There is little doubt that economic activity has improved with manufacturing and service sector activity accelerating but retail sales growth has been weak and more importantly, the annualized pace of consumer price growth slowed in the month of March. The strong currency also puts further pressure on inflation and as long as the risk of a jump in inflation expectations is low, the BoE may prefer to keep monetary policy steady for the time being. They could still upgrade their economic forecasts and express more confidence in the economy, which may be enough to lift the currency and satisfy sterling bulls but a strong break above 1.70 should require a clearer guidance from the central bank. In other words, sterling could rise even if the central bank doesn’t commit to tightening. In terms of policy, inflationary pressures are confined to the housing market and instead of tightening the U.K. government could opt to scale back the Help to Buy Scheme or impose restrictions on mortgages as a first step to cool growth in a very overheated sector. Back in February, the central bank indicated that a rate hike hinges upon qualitative measures such as spare capacity, which is measured in part through wage growth. U.K. labor market numbers are scheduled for release on Wednesday and an increase in average hourly earnings could give GBP/USD a boost ahead of the Quarterly Inflation Report.

USD: No Tightening without Spending

Based on the price action in equities and currencies, investors were unfazed by today’s softer retail sales report. While the decline in the dollar was modest and inconsistent both the Dow and S&P 500 climbed to record highs after the release. The lack of a reaction to such a critical report has to do with the belief that the slowdown in spending will not distract the central bank from its plans to taper asset purchases by $10 billion at each successive meeting. However today’s retail sales report does explain why the Federal Reserve has been reluctant to give a clear timing on their first rate hike. Consumer spending rose only 0.1% in the month of April against expectations for a 0.4% increase. Excluding auto and gas prices, spending actually declined 0.1% last month and while the numbers for March were revised sharply higher, the improvement in the labor market and the balmy April weather should have encouraged consumers to spend. Instead they pulled back, raising concerns about second quarter growth. Americans cut back on online spending, eating and drinking and spent less on big-ticket items such as furniture and electronics. The main reason why high unemployment is a concern for the central bank is because of the impact that it could have on spending and growth so while the jobless rate has declined, the reduction in demand will keep the Fed cautious and monetary policy easy particularly in an environment of low inflation. Import prices also fell 0.4% last month – a direct consequence of the rebound in the dollar in April. In a nutshell today’s economic reports explain why the central bank is noncommittal about monetary tightening and why investors expect rates to remain low. A number of other U.S economic reports scheduled for release this week but today’s reports have set the tone for trading and should limit the dollar’s gains in the coming days.

EUR Extends Losses as Weaker ZEW Reinforces Need to Ease

Dovish comments from the Bundesbank and weaker economic data from the Eurozone extended the losses for EUR/USD. According to a report by the Wall St Journal, the Bundesbank would be comfortable with increasing stimulus after the ECB forecasts are released in June. While they haven’t decided on the matter yet, they are “open to a package of measures from a negative deposit rate to halting the sterilization of crisis-era bond purchases.” These comments reinforce our view that the central bank will increase support to the economy through a series of smaller measures. As for the ZEW survey investors grew more optimistic about current conditions in Germany but their outlook for the region deteriorated. According to our colleague Boris Schlossberg “The net takeaway from the report was that Germany continues to perform well, but investors are gravely concerned about the sustainability of that growth given the chaotic geo-political conditions in Ukraine and the elevated level of the exchange rate that is likely to weigh German exports going forward. No doubt investment managers have already noticed the declining level of German factory orders and Industrial Production and the ZEW reading today simply reflects the fact that investors do not think that the heady pace of growth in Q1 is sustainable.” We continue to believe that EUR/USD is headed for a move down to 1.3650-1.3600 with the next potential catalyst being Thursday’s first quarter GDP report.

AUD Shrugs Off Weaker Economic Reports

The Australian dollar shrugged off weaker Chinese data and a tough budget to end the day unchanged against the greenback. The Australian dollar actually had very little reaction to the Budget, which is forecasted to be -$29.8 billion for FY 2014/2015, not far from the market’s -$30 billion estimate. Their growth and inflation forecasts were only slightly lower than the Reserve Bank of Australia’s but in general, there were no major surprises. Nonetheless, over the longer term, the belt tightening measures by government are slightly negative for the Australian dollar because of the risks that it poses to growth. The latest housing market reports should have also been bearish for AUD with home loans falling in March and house price growth easing on a quarterly basis. At the same time, Chinese retail sales and industrial production growth eased in April, a sign of the slow and uneven recovery in China’s economy. Last night’s economic reports have not altered the uptrend for AUD which is benefitting from the decline in U.S yields. The best performing currency today was the New Zealand dollar, which bounced after 4 days of losses. Food prices increased, lending support to the currency. New Zealand retail sales are scheduled for release this evening and despite stronger employment, spending is expected to slow. The Canadian dollar on the other hand held steady versus the greenback.

USD/JPY Could be Supported by Further Gain in Nikkei

Despite the new highs in U.S. equities, drop in Treasury yields and rally in the Nikkei, there was very little consistency in the performance of the Japanese Yen today. Part of that has to do with the lack of Japanese data overnight. With the Government Pension Investment Fund expected to increase its exposure to Japanese assets, the recent rally in local equities could become a lasting trend that is supported by easy monetary policy. While the Bank of Japan has shown no desire to increase stimulus, they are still expected to ease this year and more importantly, they won’t be tightening policy anytime soon. This provides the perfect backdrop for a stronger rebound in stocks that could in turn lend support to USD/JPY. The Domestic Goods Price index and Machine Tool orders are scheduled for release this evening. We don’t expect these reports to have much impact on USD/JPY, which should remain confined within a 101 to 103 trading range.

Kathy Lien
Managing Director

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