ECB surprise cut sinks Euro
11/Nov/2013 • Currency Updates•
We had been pounding the table for some time that the inflation shocker in the eurozone meant that further ECB rate cuts were a distinct possibility and explicitly called for one at either last week´s meeting or at the latest, the next. The ECB council went on to deliver that cut, surprising the majority of analysts. After dropping about 1.5% in a matter of minutes. It attempted a half-hearted recovery over the following day, only to fall back down after a stronger-than-expected payroll report came out in the US. Dollar strength dragged along Sterling, which ended the week about flat against the greenback and consequently sharply higher against most G10 and merging market currencies.
Last week brought yet another spate of strong macroeconomic news out of the UK. Industrial production in September surprised to the upside, coming it at nearly twice the level assumed by the third quarter GDP report. The PMI index of service business sentiment rose to 62.5, a new cycle high and within sight of the all time high of 63.5 The employment component jumped three points, which bodes well for a continuation of the surprising (and almost unique among major economies) strength in UK job creation. All eyes are now on the impact this strength will have on next week´s Inflation Report, which is expected to outline the views of the Bank of England on future inflation, employment, growth and interest rates. The strength in the data allowed sterling to keep up with the soaring dollar, and therefore rise sharply against nearly all other major currencies.
We correctly assumed that the shocking drop in eurozone inflation would spook Draghi and most of the ECB into action. The eurozone now sports the lowest inflation of any major economic area, Japan included. Particularly worrisome is that outright deflation is close to becoming a reality in the large peripheral economies, and their massive public and private debt loads mean that they can ill afford it. Next week´s GDP reports are expected to show yet another quarter of permacession, with growth barely positive and nowhere near levels sufficient to turn around the labour market. As both economic data and prospects for monetary policy continue to diverge in both sides of the Atlantic, we maintain our bearish view of the common currency.
An outstanding payroll report capped a very positive week for the US dollar. A net +204,000 jobs were added in October, and the previous two months were revised up by a combined +60,000. The apparent job market swoon that had led many analysts to push their forecast for the taper well into 2014 has now been largely revised away. As expected, the household survey, where people report their status, was affected by the Government shutdown. Both the number of employed and the labor force fell sharply. We expect these effect to go away by the next report.
After these strong numbers, we are calling for the FOMC to announce the beginning of the taper at its January meeting, absent nasty surprises in the two job reports that will be released between now and then. We are now considerably more confident on our bullish outlook for the dollar.