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FX Update - The central bank focus increases and paths diverge

Written by Ian Dobbs on August 26th, 2014.      0 comments

Market Overview:
It has been a long time coming, but divergence between the major economies and the corresponding central bank policies looks to be almost upon us. Whilst last weekend’s central bank symposium at Jackson Hole was a mostly dull after, its seems likely that the US Federal Reserve (Fed) and the Bank of England (BOE) will have divergent monetary policy changes from the European Central Bank (ECB) and Bank of Japan (BOJ) in 2015. With the Fed and the BOE steering towards slight normalisation of monetary policy at some stage in 2015, the ECB and BOJ are pointing in the other direction as they look to starve of the prospects of deflationary pressures. With interest rates providing fundamental drivers for the foreign exchange market overtime, these influences are likely maintain the spotlight in the coming years. The obvious implications for the Australasian currencies are the move lower as interest rate differentials close up, albeit we are not at that point yet.

When RBA Governor Stevens spoke last week he seemed to downplay the chance of any further monetary policy easing’s. He highlighted the limitations of monetary policy in fine tuning economic outcomes over short periods and said rate cuts are not the answer to rising unemployment. Those issues need to tackled by government policy and it certainly seems that barring a big shock of some sort, the RBA will be on hold of the foreseeable future. It may have been that the governor taking rate cuts off the table helped the Australian dollar to be one of the best performers last week. While it did lose a little ground to the USD, it didn’t lose anywhere near as much as other currencies and as such the AUD gained on many crosses. The focus the week will be on private capital expenditure figures released Thursday. Ahead of that we also get construction work done data on Wednesday.

New Zealand
Last week saw a couple of releases that helped to push the New Zealand dollar lower. Producer prices came in very weak and inflation expectations also declined. These kept pressure on the NZD and then early yesterday morning, in thin market conditions, the currency lost half a cent to the US in complete absence of any news flow. There has been some speculation that maybe the RBNZ intervened, but that seems very unlikely. If they weren’t selling at 0.8700 and 0.8800 why would they be selling at 0.8400 when the NZD is already going the way they want it to? It’s more likely just a flow that has come into the market at the worst time of the week and perhaps triggered stops in the NZDAUD below 0.9000 (buying AUDNZD 1.1110). The most interesting aspect of the price action is the complete failure of the currency to recover since. The NZ dollar downside remains the more vulnerable. In the last few hours we have seen trade balance data which showed a bigger than forecast deficit. A fall in exports was the driver lead by dairy and pine logs.

United States
I think it’s fair to say the market was left largely uninspired by Fed Chair Janet Yellen’s speech at Jackson Hole this past weekend. It was so balanced she almost said nothing. The USD has made some gains in the wake of the speech, but only because she wasn’t as ‘dovish’ as she could have been. She did say that faster progress towards the Fed’s goal may bring rate rises sooner, but that’s far from signalling any confidence in the matter. US data over past few weeks has for the most part been extremely positive. If a recent Reuters article is to be believed, pressure is building within the Fed for officials to clearly acknowledge improvements in the economy and lay the groundwork for the first interest rate hike in a very long time. History has shown that holding rates too low for too long only creates bigger problems down the road and the time has come for Yellen to jump off the fence and lead from the front. We get further key pieces of the economic puzzle this week with the release of durable goods orders, consumer confidence and GDP.

United Kingdom
The minutes from the Bank of England’s (BOE) most recent meeting were released last week and they showed that two of the nine monetary policy committee (MPC) members actually voted for a rate hike. This is the first split in the voting pattern seen for a long time and we may well see other members move across into the ‘hawkish’ camp over the coming months. Last week’s data won’t have helped that cause however, with inflation and retail sales both coming in somewhat softer than forecast. But the real hurdle holding Governor Carney and the others back from voting for a hike is the lack of wage growth in the economy. Carney believes low wage growth is an indicator of ‘slack’ or ‘spare capacity’ in the economy and therefore the economy can be allowed to grow at a faster rate without creating inflation pressure. Trying to quantify spare capacity is extremely difficult at the best of times, and there could be other factors at play restraining wages. Growth in the UK is strong and there are now more people in employment than at any other time since records began in 1971. If Carney and co are wrong in their judgment of spare capacity, they could find themselves well behind the curve. This week sees only second tier data set for release in the form of mortgage approvals, CBI realized sales, the house price index and preliminary business investment.

ECB President Mario Draghi gave a speech this past weekend at the Jackson Hole symposium that could mark a real turning point for how Europe deals with its very lacklustre recovery. Draghi drew focus to declining inflation expectations and said the central bank “stands ready to adjust our policy stance further”. Some sort of quantitative easing could well be on the cards for Europe over the coming months, but in his speech Draghi highlighted the need for action on both supply and demand side policies. He clearly highlighted the need for fiscal policy changes to help boost demand. Fiscal policy is the domain of governments, and it seems even Draghi is now urging Europe to move away from the German imposed ‘austerity policies’ to something more growth friendly. Support for the idea was immediately seen from the French economy minister who on Sunday said the time has come for France to resist Germany’s “obsession” with austerity and promote alternative policies across the Eurozone that support household consumption. With the ECB now clearly in their corner the rest of Europe could unite and force a back down from Germany over near term deficit reduction. This could only be positive for Europe's economic outlook. Last night’s release of the German Ifo business climate index saw a weaker than expected result as the index moderated further from the peak set earlier in the year. Still to come this week we get German unemployment and retail sales. While from the Eurozone as a whole we have inflation and unemployment to draw focus.

The only data of note from Japan last week was the trade balance and manufacturing PMI. Although the trade balance came in below forecast we did see an improvement in exports which could be a positive sign going forward. Manufacturing PMI on the other hand did see an improvement over last month coming in above expectation at 52.4. BOJ Governor Kuroda spoke at the Jackson Hole symposium this weekend and he suggested that Japan was “halfway” to achieving its goal of price stability. He added the labour market is showing significant improvement, although wage growth was critical to reverse deflation. To reverse deflation there needs to be some kind of coordinated mechanism. He believes monetary policy still has power over the economy and accommodation will continue until price stability is seen. There is no data of note until Friday when a number of key releases hit the wires. These include household spending, inflation, industrial production and retail sales.

Last week saw some mixed data from Canada, but overall the impact on the currency was positive. Wholesale sales came in better than forecast at +0.6% and this was followed on Friday by a very strong reading for retail sales. They came in at +1.5% against expectation for +0.4%. This is also a big improvement over the previous reading of just +0.3%. That retail sales number completely outweighed the negative impact of inflation data that actually declined a touch. Core inflation was down 0.1% on the month vs expectations for +0.1%. Year on year for July inflation was 2.1% vs expectation of 2.2%. This won’t be of much concern for the central bank who are firmly on hold for the foreseeable future. Governor Poloz says the economy has “lots of room to grow” and we can expect interest rate to stay where they are well into 2015.

Major Announcements last week:
  • UK CPI 1.6% vs expectation of 1.8%
  • US building permits 1.05m vs expectation of 1.00m
  • US inflation 0.1% as expected
  • Bank of England vote 7 - 2 to hold rates steady
  • Canadian wholesale sales +0.6% vs expectation of +0.4%
  • Chinese manufacturing PMI 50.3 vs 51.5 expected
  • French manufacturing PMI 46.5 vs 47.9 expected
  • German manufacturing PMI 52.0 vs 51.7 expected
  • UK retail sales +0.1% vs +0.4% expected
  • Canadian inflation -0.1% vs +0.1% expected
  • Canadian retail sales +1.5% vs 0.4% expected