Daily Forex Fundamental Overview

Fundamental Analysis

Fed gets ready to end QE, BoE split on rate hike, ECB considers additional actions

Despite the recent volatility in financial markets the Fed is expected to end its bond-buying programme as planned at the end of the current month despite the recent market volatility. The Fed is set to wind down its bond-buying stimulus at its meeting next week, but also said it will keep interest rates near zero for a "considerable time" after the end of bond-buying. The Fed is still likely to start raising interest rates in mid-2015, although it now seems a little less likely that the central bank would act sooner, and there are more chances it would wait longer amid concerns about persistently low inflation. Fed oficcials meet on 28-29 October to decide whether to withdraw its bond-buying programme as planned, and what language to use to communicate when they will raise borrowing costs.

Meanwhile, the world’s second-biggest economy China, posted the slowest economic growth since the global financial crisis in the third quarter and risks missing the oficcial goal for the first time in 15 years, reinforcing the view the world's number two economy is becoming a drag on global economy. China's GDP rose 7.3% in the July-September quarter from the previous year. Nevertheless, China's government said previously it would tolerate economic growth slightly below the oficcial target this year by refraining from broad stimulus.

In the UK, a major positive spotlight in the global economy, oficcials remained split on hiking interest rates, with the majority of policy makers voted against immediate rate lift, while two oficcials were in favour for the third consecutive month. However, all MPC members were unanimous on maintaining the asset purchase facility unchanged. Thus, the MPC agreed in October to leave the BoE's benchmark interest rate at all-time low of 0.5% and the total size of its bond-buying stimulus programme unchanged at 375 billion pounds.

In the previous week, the ECB bought Spanish, French and German covered bonds with maturities from one to six years. The central bank will publish the exact amounts purchased every Monday. The other part of its asset-buying programme, the ABS purchases, will begin in the fourth quarter and will be accompanied by another tool, a second round of TLTROs, or four-year loans at ultra-cheap rates offered to the region's banking sector. On top of that, the central bank is pondering to purchase corporate bonds on the secondary market and may make the corresponding decision as soon as December, several people familiar with a matter said. The central bank may begin buying bonds already in the beginning of next year. This would expand the recently launched private-sector asset-buying scheme, part of a private-sector asset-purchase programme that will also see it buy asset-backed securities later this year. It is estimated that the central bank could inject one trillion euros into the Euro zone's financial system. These measures are aimed at increasing lending to businesses and thereby support the Euro zone economy. However, there is concern at the ECB that these measures may have an insuficcient effect to help support the economy.

EUR

“Expectations with regard to the six-month business outlook continued to cloud over. The outlook for the German economy deteriorated once again.”

- Hans-Werner Sinn, Ifo president

ECB’s year-long examination of banks asset strength and ability to withstand economic turbulence showed that 25 banks including nine Italian failed stress test, with capital shortfalls totalling 25 billion euros. Half of those had already taken actions to remedy their alleged failings, while others have nine months to shore up their finances or risk being shut down. However, the Euro zone’s largest banks have increased their capital buffers by 200 billion euros since plans for the test were first announced last year. The fear of failure that drove those amendments is more important than the fact that 25 banks have failed the stress test. In the meantime, the mood among German businesses deteriorated again in October, as growth concerns in the Europe’s largest economy influenced the overall economic sentiment. Germany’s IFO business confidence barometer declined to the lowest level in nearly two years, with the corresponding index falling to 103.2 in October down from 104.7 in the previous month. The Current Assessment sub-index dropped to 108.4, following a figure of 110.5 a month ago. Moreover, the Ifo Expectations Index, which indicates firms' projections for the next six months, came out at 98.3, down from 99.3 in September. Germany’s export-oriented economy is suffering from sanctions by the EU and the U.S. against Russia and instability in the Middle East. A slowing economy in China, Germany’s third-largest trading partner, and subdued demand from its Euro region neighbours are adding to risks.

USD

“Overall tone of the communique should feel dovish as the Fed counters the implied tightening in monetary conditions resulting from the strong dollar and leans against the potential fallout from the current global growth slowdown and disinflationary impulse"

- Millan Mulraine, economist at TD Securities

The Federal Reserve this week will likely reiterate its willingness to wait some time before increasing interest rates following a volatile month in financial markets that saw some gauges of inflation expectations decline worryingly low. On Wednesday the central bank is expected to announce the end of its aggressive asset-purchasing programme. The critical question now is to what extent central bankers acknowledge threats to their expectations that the American recovery will continue to accelerate and allow them to hike rates in the middle of 2015. The Fed could highlight the risk that inflation might stay below central bank’s goal for longer than previously estimated. It could also stress the risk that a global slowdown could pose to the US growth. On the other hand, the unemployment rate has dropped to 5.9% and the economy is expected to grow at a 3% pace in the second half of this year and next, adding to evidence of improving domestic picture, which would urge the central bank to tighten its monetary policy soon.

In the meantime, contracts to purchase previously owned homes rose less than predicted in September, with Pending Home Sales Index climbing 0.3% to 105.0 following the 1.0% fall in the preceding month. A separate report from Markit showed a slowdown of activity in the services sector to the lowest level in six months. The preliminary services sector PMI slid to 57.3 in October, down from 58.9 a month earlier.

GBP

“By the middle of next year, the remaining level of slack is likely to be small, if any remains at all”

- Ian McCafferty, BoE policymaker

The Bank of England should start lifting interest rates now, as spare capacity in the UK’s economy could be used up by the middle of next year, adding to inflation pressures. Ian McCafferty, one of two MPC members, who voted for rate lift since August, reiterated his belief that increasing borrowing costs now would help the central bank to raise rates gradually. His comments came on the back of soft economic data out from Britain, where inflation stands at 1.2%, the lowest level in five years and well below the BoE’s inflation goal, as well as uncertain global economy outlook. Nevertheless, McCafferty highlighted that the amount of spare capacity in the economy had been used up quite quickly and would continue to shrink despite a possible moderate growth pace likely through the winter. He also said that growth of wages should accelerate, as unemployment rate tumbled to 6% in the three months to August, compared to 7.7% a year ago, and other indicators of the labour market point to improvement. Lower commodity prices and a strengthening of the Pound, which makes imports cheaper, were the main drivers behind the drop in inflation, according to MCCafferty.

The BoE slashed interest rates to all-time low of 0.5% in early 2009, at the height of the global financial crisis, and has maintained them unchanged ever since, even as the nation’s economy began to recover more strongly in 2013. Minutes last week showed still the majority of rate-setters are firmly against raising interest rates now.

JPY

“There's a great danger from the next sales tax hike given the current situation where the positive effects of 'Abenomics' and the negative impact of April's sales tax hike are offsetting each other”

- Etsuro Honda, professor at University of Shizuoka

Japanese industrial production probably slightly recovered in September, whereas consumer price inflation may have fallen, adding to uncertainty whether the Japanese government will proceed with a planned sales tax hike again next year. Moreover, unemployment rate may have increased last month. Japan’s factory output probably climbed 2.2% in September from a month earlier following the revised 1.9% drop in August. Separate government data on 31 October is seen to show that core consumer price inflation slowed in September, adding to signs the Bank of Japan may need to deploy further easing steps to reach its 2% inflation target for next fiscal year.

Prime Minister Shinzo Abe has to decide this year whether to proceed with another sales tax increase next October, lifting it to 10% from 8%. April's hike from 5% caused the world's third-biggest economy to contract an annualized 7.1% in the three months through June. A top Japanese government oficcial believed Prime Minister Shinzo Abe should delay a planned sales-tax increase by a year and a half to April 2017, the strongest sign yet that economic weakness is causing concern among politicians that are close to the Premier ahead of the dificcult tax decision. However, the Finance Ministry, the Bank of Japan and major corporations urge Abe to raise the tax as planned next year to keep Japan's pledge to cut the biggest debt burden in the industrial world.