Euro could weaken following ECB decision this Thursday
19/Oct/2015 • Currency Updates•
The Euro was under pressure late last week after comments from an ECB member seemed to suggest that further quantitative easing was necessary to stimulate the Eurozone economy. We believe an expansion of the programme would likely see the Euro return to the low levels seen late this summer, which would be great news for Euro buyers but of course a large worry for Euro sellers.
Up until Thursday, the Euro was revisiting higher levels not seen since the violent market moves of August, dragging Sterling up with it. Then, Thursday morning, ECB member Ewald Nowotny hit the wires with very dovish comments, stating the (obvious) fact that both headline and core inflation were “clearly” undershooting the ECB’s target, and suggesting further monetary stimulus was on the way.
The Euro immediately backed off its highs, and it was pushed further downward by some fairly positive US data out later that day.
In the end, most G10 currencies ended the week roughly where they started it, with the conspicuous exception of the Australian and New Zealand Dollar. They had a most unusual week, moving in exact opposite directions (Kiwi up, Aussie down) as long Australian Dollar trades were unwound in illiquid markets.
More jitters over a slowdown in the US economy and the delays it would cause in the timetable for Fed hikes weighed down the US Dollar earlier in the week. In fact, the Dollar suffered the most last week of the three major currencies with disappointing retail sales figures leading to a slight sell-off on most Dollar markets.
However, given the low jobless figures, most forecasters are pointing towards a strong payroll report for early next month. Given the uncertain nature of interest rate hikes over the coming months, these data points are of highest importance.
Major currencies in detail
Last week’s data out of the UK provided ammunition for Bank of England doves.
Inflation and pay growth both came in lower than expected, leaving core inflation up just 1% on the year and weekly earnings, excluding bonuses, at just 2.8% – down from the previous month’s 2.9%. This data almost certainly rules out a first-quarter 2016 interest rate hike from the Bank of England.
On the other hand, we think market expectations are excessively dovish. We expect pay rises to respond to tightening in the labour market and nominal increases in earnings to move closer to 3.5% over the coming months. This would support a rate hike sometime in the second quarter of next year and provide modest support for Sterling against the Euro.
All eyes are rightly fixed on Thursday’s key ECB meeting.
After last week’s disappointments in industrial production (down 0.5% in August) and with inflation back below 0% in September, we expect the ECB to acknowledge this weakness and the increasing downside risks to the Eurozone economy.
However, we don’t expect any announcement of an actual expansion of the QE programme – the ECB’s institutional inertia ensures it only responds to events with a significant lag – but clear comments from President Draghi and a suggestion that further weakness will be met with additional stimulus. This should provide moderate downward pressure on the Euro over the coming weeks.
We saw another week of mixed-to-negative economic reports out of the US.
Retail sales in September were surprisingly weak, even after excluding the effects of lower oil prices. Core retail sales dropped 0.1% for the month in annualised terms, though the three-month running average is still above 2%.
However, there was positive news from the inflation reports, where core levels increased a significant 0.2% thanks to widespread rent increases. The level now nears the Fed’s target at 1.9% annualised.
Also jobless claims are set yet another low for the cycle. This bodes well for the all-important October payroll report out in the first week of November, which we consider critical for the Fed decision on whether to hike interest rates in December, as we expect, or wait till 2016.
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