Fundamental Update: BOE and ECB Meetings, What Now?

The first meetings of the year for the Bank of England and the ECB went as expected. Both Banks kept rates on hold, but it was the ECB that everyone was looking out for.

ECB Draghi’s press conference post the rate decision included a few important points that the market needs to be aware of: 1, Draghi believes that economic deterioration in the currency bloc could have bottomed. 2, He also said that the LTRO programme was a success and 3, that Europe will avoid a credit crunch. Draghi continues to be against QE or stepping up the SMP programme to buy more peripheral debt, added to that he pressed governments to sort out this crisis, reinforcing the Bank’s stance that it is not up to the ECB to clean up the sovereign debt mess.

He also said that risks to inflation were broadly balanced and although the economy is showing signs of stabilization there is still a lot of uncertainty out there. So what does all of this mean for the markets? Draghi is keeping his powder dry when it comes to future rate cuts. Many people believe that rate cuts are a matter of months away, after all the ECB rate is 1% so there is room to manoeuvre on this, however, Draghi and co. at the Bank may not be so sure especially since real interest rates are negative anyway.

Apart from his praise for LTRO, the next auction is scheduled for next month; Draghi didn’t announce any new policy support for the debt-addled currency bloc. Draghi’s defence of LTRO was spirited: he said that it worked, that funding conditions had eased and that this measure has avoided a credit crunch in the region. These are all worthy points, but what about the fact that banks are now depositing just as much with the ECB on a nightly basis as they borrowed from it in the first LTRO auction? Draghi’s response was that the banks that were doing the depositing were not the same ones that were doing the borrowing. He should know, so we’ll take his word for it, but that doesn’t mean a credit crunch is out of the way. Banks aren’t lending the money they are boosting capital levels and re-financing. Since corporations in Europe use banks for 80% of their funding requirements this isn’t good news, and surely if credit lines dry up this will weigh on the economy even more than expected thus forcing the ECB to take more dramatic action?

This is our view, which is surely euro negative in the medium-term. But not so in the near-term. EUR/USD had a stunning reversal of fortune today and as London leaves for the day is testing 1.2840/45 highs. There are a couple of reasons for this rally 1, the fact the ECB didn’t do anything else suggests that concerns have eased a little so that Draghi could comfortably say that the economic condition in the currency bloc had stabilised. This was played out today when Italy and Spain both had stunning debt auctions to kick start the year. 2, expectations that there will be future rate cuts and accommodative action from the Bank to ensure things don’t deteriorate further. So the euro rallied because there were no rate cuts today, but also because there is an expectation of one in the future… Logic is missing somewhere, surely, but that hasn’t stopped the euro.

And the signs look good for the euro to go a little further. It is above its 200-hr sma at 1.2830, which opens the way to a recovery towards 1.2950. A double bottom has formed on the 4-hourly chart at 1.2670/80, which is a bullish reversal pattern, which suggests an intermediate change in trend. This doesn’t mean that EURUSD will be back at 1.40 anytime soon, but it could try and test resistance at 1.2950 and then maybe even 1.30 in the medium-term.

This meeting was always likely to be boring for the Bank of England; they are expected to boost QE next month, which should be pound negative. GBP/USD remains close to the 1.5270 17-month low that is holding as support for now. But for how long? Below here opens the way to 1.4250 zone from mid-2010.

The euro and the pound were boosted by a weak dollar. Retail sales less autos saw their largest monthly decline since early 2010 in December and initial jobless claims are perilously close to the 400k mark, suggesting that the boost to employment in recent months was fuelled by temporary holiday workers. Now that consumption looks weak again don’t expect this to continue. So much for the US de-coupling and it becoming the engine of global growth. No wonder stocks closed lower in Europe and Brent and WTI have given up some of their gains.

EUR/USD: 4-hourly chart, a double bottom is forming around 1.2670.