ECB February refi cut in store; RBA goes neutral on AUD

We now look for the ECB to cut the refi rate by 10bp on Thursday’s meeting, see ECB Preview: Another refi rate cut . First of all, euro-zone inflation declined again and it is now almost certain that inflation in Q1 will be below the ECB's December staff projection. Second, the surge in money-market rates seen at the start of the year is a another concern for the ECB. Also, the case for further ECB action has strengthened by monetary development data, which showed further weakness in December, and bank lending remains alarmingly weak. The most likely response is a refi rate cut to 0.1%, while keeping the deposit rate unchanged at 0%. The Governing Council may also consider stopping the sterilisation of SMP purchases, which would increase the liquidity surplus by almost EUR180bn. Even though the EONIA market is pricing some probability of further easing from the ECB, we would expect a refi rate cut to result in a decline in money-market rates. Moreover, as we wrote yesterday, we see good potential for a move lower in EUR/USD below 1.34 on an ECB cut this week.

The Reserve Bank of Australia (RBA) overnight kept its cash target rate unchanged at 2.50% but notably the statement likely implies a significant shift in the RBA policy stance to a much more neutral outlook than previously seen. The RBA explicitly said it expects stable interest rates ahead (rather than cuts as we have been calling for) and remarkably dropped the long-standing saying that AUD is ‘uncomfortably high’. This is a key shift in policy stance from a central bank that has not missed a chance over the past year to talk AUD weaker still. We deem that this will likely halt the AUD downside somewhat despite continued weakness in China and we are now considering whether to take profit on our “short AUD and CAD against USD” basket from FX Top Trades 2014: How to position for the coming year. We note that both AUD/NZD and AUD/CAD have strengthened markedly on the announcement.

Danmarks Nationalbank (DN) will publish January currency-reserve figures today. EUR/DKK has traded above the central rate and perhaps close to intervention levels the past couple of weeks; hence, it cannot be ruled out that DN has had to step into the market to support DKK. We expect it will take around DKK10-20bn of intervention before DN raises interest rates independently. If no or little intervention was seen in January, an ECB refi cut on Thursday should not spark a DN reaction; only if the ECB goes “all in” and cuts the deposit rate as well, then DN would likely reduce the certificates of deposit rate. Note that a refi cut from the ECB could potentially help to reduce the carry in a long EUR/DKK position.