Weekly FX Market Outlook: ECB May Stay Behind the Curve

European Central Bank is to set interest rate this week along with other central banks in Britain, Australia, and New Zealand. While a rate cut is almost certain for all of them, the reaction from the euro may be different; probably much more dependent on the size of reduction.

ECB Rate Decision and the Euro
Look at the interest rates among the G-7 members and you see that the ECB has the highest. It might be natural in usual times but many believe it is by no means usual now.

Recent reports from the IMF suggest that it may be the first time since World War II that all major economies could fall into recession together. GDP figures last month showed that Germany and Japan have already entered into recession.

Last week reports from the Euro-zone also showed the unemployment started to rise, inflation has fallen sharply, and it is when the global slowdown makes the prospect for exports increasingly gloomy.

In response, the ECB has lowered its benchmark interest rate but in less aggressive manner. The ECB cut interest rate by 0.5 percent in November when the Bank of England’s MPC unanimously voted for 1.5 percent cut in the bank rate just at the same day.

So a very simple question comes to the analysts’ minds: Why the ECB can’t see what the other central banks clearly see?

The answer could also explain why the euro reaction to the interest rate decision could be much more dependent on the size of reduction. A small rate cut on Thursday is likely to strengthen this view that the policymakers are still behind the curve, ignoring the economy’s weakness now, and may be forced to take much more actions later.

BOE, RBA, and RBNZ Set Interest Rate
Bank of England, Reserve Bank of Australia, and Reserve Bank of New Zealand are scheduled to set interest rates this week.

In the case of the bank rate in the U.K., one should also take the last week pre-budget report into account. The Labor Government is to follow a considerable budget deficit by cutting taxes (yes some say it is just for the Christmas!) and huge increase in spending.

The BOE Monetary Policy Committee announces its decision on Thursday Dec. 4, and they will certainly consider the long-term effect of the fiscal policy. However analysts say Mervyn King did little to lower expectations for further reduction when speaking at the Treasury Select Committee on Nov. 25.

U.S. Employment Report
Reports this week may show the recession is deepening in the U.S. The Employment Report on Friday probably show that the economy has lost more than 300 thousands jobs in November. The unemployment rate may continue to rise as businesses struggle to survive.

Manufacturing and Service indexes from the Institute of Supply Management are due on Monday and Wednesday respectively; both are expected to come below 50 which is dividing line between contraction and growth.

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