A tale of two central banks: Bank of Japan delivers aggressive easing while ECB stays put
08/Apr/2013 • Currency Updates•
Volatility returned to currency markets with a vengeance late last week. After a rather sedate beginning, the fireworks started very early Thursday morning. The Bank of Japan shocked markets by announcing a dramatic unconventional easing of policy that went far beyond expectations. It will double the size of its balance sheet by the end of 2014 by buying just about every financial asset, from Government bonds to stocks and even real estate investment trust, as it commits firmly to achieve 2% inflation in this time frame. Traders reacted immediately by selling the Yen, which lost over 2% against the dollar by the time London woke up. Sharp moves continued on Thursday, as neither the Bank of England nor the ECB followed the Bank of Japan easing lead, disappointing some investors, and sending their respective currencies higher against the dollar. Finally, the all important payroll report in the US on Friday came in considerably weaker than expected, throwing fresh doubts on the speed of the US economic recovery and sending the Euro higher. The common currency rose by 1.3% against the dollar, 0.5% against Sterling, and a whopping 5% against the Yen – adding a strong currency to the litany of woes afflicting the European economy.
In contrast with other major currency markets, last week turned out to be relatively quiet for Sterling. There was no change in policy at the MPC meeting on Thursday, and as usual when that is the case, no communique was released either. Macroeconomic news did not change our expectations for growth in the first quarter of 2013. The composite PMI business sentiment index was nearly unchanged at 51.4, which would be consistent with slightly under 1% growth in sectors outside construction. Weak construction and the unusually cold weather lead us to expect a flat outturn in GDP growth. We were disappointed that the Bank of England did not increase the size of the Gilt purchase target last week, but expect them to do so in May in conjunction with the release of the Inflation Report.
The big event of the week in Europe was the April meeting on Thursday. The quickly worsening economic conditions had lead some observers (ourselves among them) to expect either a cut in rates, or , at the very least, additional easing measures out of the Governing Council. In a melancholy statement, the ECB freely acknowledged the worsening outlook for the Eurozone economy as well as below target (and dropping) inflation. However, not only was there no action, but Draghi went so far as to argue that there was not much the ECB could do in the circumstances – a puzzling statement that seems to point to some strange thought patterns among European monetary authorities. Beyond the Frankfurt bubble, the Eurozone economy continues to deteriorate. Loans to households and corporations have failed to benefit from the improvement in sovereign debt markets, and in the periphery the situation continues to worsen, as lending contracts and rates climb. Eurozone unemployment rose to yet another record, and retail sales contracted again in February. The disappointing jobs report in the US granted the common currency a reprieve this week, but it also highlighted that currency markets are again looking at economic fundamentals. This cannot be a medium-term positive for the Euro.
Macroeconomic news out of the United States last week took a somewhat disappointing turn, particularly in the job market. March employment rose by only 88,000, about 60% below the average of the previous five months. Though the unemployment rate dropped again to 7.6%, this was mostly due to a decline in participation on the labor force. Both PMI business sentiment indicators declined, though they remain at levels consistent with moderate growth. While first quarter growth will post a sharp rebound from the near flat reading of the last quarter, we are paying very close attention to these early signs of a spring slowdown in the United States. For now, we remain confident that the US can continue to post growth between 2% and 3% for the whole year.