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FX Update - Slowing Chinese growth prompts a response from the PBOC

Written by Ian Dobbs on November 25th, 2014.      0 comments

Market Overview:
The People Bank of China surprised markets on Friday evening by announcing a cut in interest rates in an effort to support the world’s largest economy. The initial reaction for the Australasian currencies was positive as anything that is supportive of Chinese demand will have flow on effects for New Zealand and Australia. But the market quickly realised the move is actually a signal of the real problems facing China going forward and this negative sentiment eventually weighed on the local pair. This was the first rate cut from the PBOC since 2012 and the question is will it be the start of a cycle of cuts. The move was designed to ease difficulties in financing for companies, especially small companies, and there has long been question marks over the sustainability of debt creation seen in the Chinese economy in recent years. Large company defaults and bankruptcies, once unheard of in China, are now occurring regularly, and house prices are declining in almost all major cities. The headwinds the Chinese economy is currently facing suggest we will see further interest rate cuts.

There has been no data of significance released from Australia over the past week. The Australian dollar did however get a boost, albeit temporarily, from news that China had cut interest rates, but a recent announcement from BHP Billiton that they are going to dramatically cut spending by up to $US4b per year has weighed on the AUD. Tomorrow we get data on construction work done and on Thursday we have private capital expenditure figures to digest.

New Zealand
Producer prices data from New Zealand last week came in much weaker than forecast suggesting there is little in the way of pipeline inflation pressure in the economy. The index was dragged down by lower farm-gate milk prices that reduced input costs for dairy manufacturers and this trend could have further to run. Fonterra’s latest dairy auction, also out last week, saw another decline this time by 3%. On a more positive note, yesterday’s migration data saw a record all time high of people coming to the country on a permanent or long-term basis. The number of net migrants jumped to 5,200 in October from 4,800 in August. It is exactly this sort of data that the Reserve Bank of New Zealand pointed to when deciding not to ease the LVR lending restrictions recently. Still to come this week we have the trade balance, building consents and business confidence numbers.

United States
The US economy continues to perform well and the Fed remains on course to hike interest rates sometime around the middle of next year. Although inflation data last week came in stronger than forecast at 1.7% year on year, long term inflation expectations are actually declining and these are unlikely to force the Feds hand on tightening. The Fed will hike because they know as well as anyone that zero rates, over the long run, probably create as many problems as they solve. Over the next couple of months we should get more clarity from the Fed on their approach to, and potential timing of, future rate hikes and this was alluded to in the minutes released last week. There are plenty of risks however, particularly to the outlook for global growth with some real question marks hanging over the prospects of China, Europe and Japan. But barring a full on crisis in one of those countries the Fed should push on with interest rate ‘normalization’. Tonight we get the second reading of GDP and the market is expecting a slight revision downward to 3.3% from 3.5% previously. This is still a very healthy result and would support the current outlook for the Fed. Other data to watch out for this week includes consumer confidence, durable goods orders and new home sales.  

United Kingdom
The Bank of England (BOE) minutes released last week suggested that they believe the recent downward pressure on inflation will ease as spare capacity in the economy is absorbed. This will push inflation back toward their target over the next 2-3 years. Although the UK economy has seen a slowdown from growth seen earlier in the year, a good portion of this attributable to the tough export environment with their biggest trading partner, Europe, floundering economically. Domestically the UK economy continues to perform well and this point is not lost on the BOE. Employment remains strong, with encouraging signs of wage gains, and last week’s retail sales numbers were much better than forecast. There are however some real risks coming from within the UK and this point was highlighted over the weekend after a by-election was won by the anti-EU UK Independence Party (UKIP). The UKIP has been gaining traction lately and now present a very real risk to the current two-party system in Britain. Should they end up holding the balance of power after next year’s election there could be some real turbulence. One recent report suggested an EU exit by the UK would result in a 10% decline of the Pound. The political situation could have a big impact on the value of the GBP over the coming months. Still to come this week we have the BOE Inflation Report Hearings, the second estimate of GDP, CBI realized sales and the Nationwide House Price Index.

Data from Europe last week was a mixed bag, although there was a hint of improvement in a couple of readings that could be considered encouraging. The trade balance improved by more than forecast and this was followed by the German ZEW Economic Sentiment Index which saw the first improved reading in 2014. Reinforcing this was last night’s German IFO Business Climate Index which improved to 104.7 from 103.2, after the previous six readings which all declined. One month’s improvement does certainly not make a trend, but is it however an optimistic signal. Countering this were last week’s PMI readings for the manufacturing and service sectors that both declined and we have also seen a number of comments from ECB officials that suggest they won’t hesitate to undertake outright sovereign QE should the inflation picture deteriorate. We are not there yet and the ECB certainly has a number of hurdles to overcome before they could start buying government bonds, but the threat of this should keep the Euro under pressure heading into next year. Still to come this week we have German retail sales, French consumer spending, inflation and unemployment data.

The big news from Japan last week were the duel announcements from PM Abe that he will delay the next planned sales tax hike, and dissolve the lower house of parliament and call fresh elections. The move came after the latest data from the July-September period showed the Japanese economy actually contracted. This surprised most economists who were expecting modest growth to save the economy from recession. The economy has taken a massive knock, and largely failed to recover, from April’s sales tax hike and PM Abe has decided he needs to seek a fresh mandate from the population to continue his economic policies, dubbed “Abenomics”. PM Abe is walking a tightrope, trying to stimulate the economy out of two decades of low growth and deflation on the one hand, while on the other trying to shore up the country's fiscal position that sees total debt at more than twice the size of the economy. It is almost an impossible task, but he is getting plenty of help from the Bank of Japan who are easing policy on a scale never seen before. These easing’s have resulted in a dramatic weakening of the Yen and it continues to remain under pressure trading at multi year lows across the board. BOJ Governor Kuroda is due to speak this afternoon and later in the week we get data on household spending, inflation, unemployment and retail sales.

The Canadian dollar saw plenty of pressure in the early part of November as falling oil prices weighed on the currency. However, recent data has been supportive of the Canadian economy and this has resulted in something of a turnaround for the currency. The positive economic numbers continued last week with wholesale sales coming in much stronger than forecast up 1.8%, and inflation also printing stronger than expected at 2.4% year on year. The forecasts were for around 2.1% y/y and it seems the recent uptick in inflation may not be as “temporary” as the Bank of Canada (BOC) expects. We get further key data this week in the form of retail sales and GDP, along with the current account and raw materials price index.

Major Announcements last week:
  • NZ Retail Sales 1.5% vs .8% expected
  • Japanese GDP -.4% vs +.5% expected
  • UK Inflation +1.3% vs +1.2% expected
  • EU German Economic Sentiment 11.0 vs 4.3 expected
  • NZ GDT Auction results -3.1%
  • BOJ leaves monetary policy unchanged
  • Chinese HSBC Manufacturing 50.0 vs 50.2 expected
  • UK Retail Sales +.8% vs +.4% expected
  • US Inflation 0.0 vs +.1% expected
  • US Philly FED Manufacturing Index 40.8 vs 18.9 expected
  • Canadian Inflation +.3% vs +.2% expected