Proactive central bankers to keep euro and sterling in check
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Foreign Exchange

Proactive central bankers to keep euro and sterling in check

Rarely have two decisions to leave interest rates on hold had such an impact on the currency market, but the Bank of England (BoE) and the European Central Bank (ECB) managed to put heavy pressure on the pound and the euro after their policy meetings on Thursday.

Both currencies tumbled against the dollar as the BoE and the ECB attempted to give the market back some of the monetary slack that the Federal Reserve’s musings over tapering its asset purchases had taken away.

Forward guidance is the new watch word among central bankers and it was the BoE that was first off the mark under the stewardship of Canada’s Mark Carney, its new governor.

The BoE surprised the market with an unexpected statement aimed at trying to turn the tide of rising market interest rates, saying the “implied rise in the expected future path of bank rate was not warranted”.

Ross Walker, economist at RBS, says: “First impressions matter and the clear impression is that a Carney-led Bank of England has a distinctly dovish bias.

“The statement sends a clear, decisive signal Carney has not spurned an opportunity to provide early guidance, which we expect to be supplemented in subsequent months.”

Sterling tumbled over two big figures against the dollar to a low under $1.51 in the wake of the announcement, its sharpest drop in 18 months as expectations over a potential rise in UK rates next year receded.

The BoE heaped pressure on the ECB to do something similar after its meeting, and the central bank duly over delivered.

The ECB formally adopted forward guidance for the first time, saying it expected interest rates to remain at present or lower levels for an “extended period of time”, a phrase that the Fed introduced into financial market folklore in March 2009.

Mario Draghi, ECB president, added to the dovish tone, saying an exit from loose policy was now “very distant” and that there had been extensive discussions over potential rate cuts.

The comments unsurprisingly hit the euro against the dollar, sending EURUSD down over a big figure below $1.29 as Euribor futures put in their largest daily increase in more than two years.

Clearly then, central bankers in the UK and the eurozone are worried about the ability of their economies to handle soaring borrowing costs, sparked by the Fed’s assessment it will reduce asset purchases later this year.

Many believe that will leave the euro and the pound facing further losses against the dollar, especially if there is further evidence of an economic recovery in the US.

Chris Turner, head of FX strategy at ING, has a three-month EURUSD target of $1.26. He says the big shift at the ECB in terms of expectation management – and the dropping of its mantra to never pre-commit to rate moves – leaves the euro vulnerable to any better US data, especially this week’s US employment report.

Turner believes the pound is more vulnerable after the BoE took aim at a market that was pricing in a first UK rate hike in the autumn of 2014 and 100 basis points of tightening by the end of 2015.

“Today’s actions will raise expectations that new Bank of England governor Carney will employ explicit forward guidance in August – when he reports back to chancellor Osborne on new intermediate targets for monetary policy,” he says.

“We tend to think sterling underperforms the euro this summer – we have a £0.87 three-month target for EURGBP, which clearly implies we think GBPUSD will be the big loser and head to $1.45.”

Contrasting monetary policy approaches across the Atlantic would appear to point to further gains for the dollar and renewed pressure on the euro and sterling.

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