Highlights

  • ECB set to confirm its monetary policy stance

  • Bank of England should continue to purchase gilts


EUR-USD treading water

Whereas the upbeat quarterly figures are sparking fresh waves of speculation on US stock markets in particular, they have had little impact on the forex markets so far. Although favourable equity markets usually tend to boost EUR-USD, the forex market has just been treading water: EURUSD started the week at 1.42, and briefly touched 1.43, only to come under pressure on Wednesday, dropping to almost 1.40. This movement was presumably triggered by the Chinese stock market plunge after reports (which have since been denied) that China could be set to tighten monetary policy. This made little impression on US and European stock markets, which began to soar in the second half of the week. As a result, EUR-USD strengthened slightly to 1.41, but ended the week lower than at the end of last week.

The markets are probably waiting for the spate of US data due to be released shortly. The advance GDP figures for Q2 will be published this Friday. The economy does not appear to have contracted nearly as much as in catastrophic Q1. It is uncertain, however, whether the figures have improved sufficiently to be regarded as a real turning point.
Next week, further important US indicators are on the agenda, including the ISM indices and the labour market data. Here too, market participants are for the most part expecting positive results, but only to the extent that the pace of decline could have slowed down. In our view, the slower pace of decline is not enough to justify breaking out of the trading range of the past weeks.

Next Thursday both the ECB Governing Council and the Bank of England Monetary Policy Committee are holding their monthly meetings. The ECB Council’s policy stance is not likely to have changed much since the last meeting. We are still expecting it to see growth and price risks as balanced: given the current Eurostat figures – the inflation rate has fallen to –0.6% in July – the pace of inflation could turn out to be somewhat lower than forecast in the last projections. Furthermore, monetary development, particularly dwindling lending activity, proves that there are no concrete price risks in the medium term. It looks as though GDP will turn out to be more or less as projected in June; however, in the meantime, the global economic climate has become slightly less hostile. On the whole, the ECB is unlikely to change its assessment of the situation.

The Bank of England is faced with more challenging choices. These do not involve the interest rate decision. Changing the bank rate is not on the agenda for the time being. However, the BoE has now exhausted its financial resources for the purchase of government bonds, £125bn. The MPC will have to decide on Thursday whether to stock up the programme to £150bn. The targeted purchase of government bonds which was started in March, was the most important element of the BoE’s quantitative easing measures. If the BoE decides not to continue with it, the market would probably interpret this as an initial exit step, i.e. as a positive sign as to the state of the UK economy. This would presumably boost the pound, at least temporarily.

We see a good chance of the BoE continuing with the programme – perhaps on an extended timescale. At –0.8% quarter-on-quarter, growth in the second quarter was disappointing. The year-on-year decline of –5.6% illustrates the extent of the collapse. The housing market is just beginning to bottom out, and credit flow is a mere trickle. All in all, the UK economy is still so fragile that a continuation of the purchasing programme would be justified.