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IronFX Daily Commentary | 07/08/15

07.08.2015, 9am

BoE disappoints; may set pattern for other central banks The Bank of England’s “Super Thursday,” during which it held a Monetary Policy Committee meeting, immediately released the minutes, and also issued its quarterly Inflation Report with new economic forecasts, surprised market participants who had expected a confirmation of BoE Gov. Carney’s hawkish line. Only one MPC member voted to hike rates – the market had expected two, and the big question was whether a third would join them. For the FX market, perhaps the main point was that the strength of sterling was a real concern for the MPC. The Bank is caught between an increase in domestic price pressures as wages rise and a fall in import prices as commodity prices fall and the pound strengthens. The minutes summed up the dilemma as follows: “(t)o the extent that the appreciation of sterling could be expected to weigh on inflation for a persistent period, the corresponding pickup in domestic costs necessary to return inflation to the target within three years would be greater.” The market took about 5 bps out of the expected tightening in GBP short-term rates and the currency weakened.

• I wonder if this concern is unique to Britain. It seems to me that with commodity prices falling, all the major central banks are likely to struggle to achieve their inflation targets. In that case, they will be particularly sensitive to the value of their currencies. Falling commodity prices and the slowing global economy may derail the process of normalizing interest rates and instead launch us on another round of “currency wars” as domestic monetary policy spills over into the international arena.

• In any event, I think it may take some time for the market to regain its confidence in GBP. BoE Gov. Carney continued with his fairly hawkish tone, emphasizing the erosion of slack in the economy and tightness in the labor market, but he isn’t the whole MPC (although he is in the middle, if not on the more dovish side). It will still take some time for the MPC to get a majority in favor of tightening. Before that happens, falling commodity prices and slowing global trade could eliminate the need for any such move, thereby wiping out the currency’s main advantage. On the other hand, that might not happen at all! The economy could continue to expand, wages could continue to rise and inflation could head back towards the target, as they expect.

• In short, it seems to me that there are the greatest possibilities for disagreement about the future course of UK monetary policy and therefore the currency is likely to be among the most volatile in the market. This should present some good opportunities for traders.

Japan holds policy unchanged, as expected The Bank of Japan kept its policy unchanged this morning, as was unanimously expected. The focus will most likely be on Gov. Kuroda’s press conference afterwards. There will be particular interest in anything he might say about the controversy over revising the CPI statistics as part of the usual revisions every five year. Gov. Kuroda still insists that the BoJ is on its way to hitting its 2% inflation target.

RBA gets a little more optimistic The Reserve Bank of Australia (RBA) came out with its new growth forecasts this morning in its quarterly monetary policy statement. The June 2016 growth forecasts were lowered to 2%-3% from 2.5%-3.5%, while the CPI forecasts were unchanged at 2%-3% and the core CPI forecasts actually raised 25 bps to 2%-3%. In other words, they expect growth to be a bit slower but inflation to be a bit higher – how’s that going to work? Same for December 2016: growth lower but inflation higher. June 2017, growth the same but inflation higher. They also said they expect that the unemployment rate has peaked. With unemployment having peaked and inflation revised up a bit, it makes sense that they could pause interest rates for the time being. That may support AUD for the time being.

• Personally, I question their forecast for both inflation and growth. With the global economy slowing, I think the fall in commodity prices is likely to continue. That may have a profound effect on the Australian economy. I expect that the RBA will eventually have to wind up cutting rates and that will cause the currency to weaken further.

Fonterra lowers milk payout forecast, as expected Fonterra Cooperative Group lowered its milk payout forecast to NZD 3.85/kg from NZD 5.25/kg. The cut was pretty much in line with expectations of NZD 3.50 - NZD 4.00. Note that at this price, most dairy farmers in New Zealand are operating at a loss. This is negative for growth in NZ and therefore makes it more likely that the RBNZ will cut interest rates and the NZD depreciate. The NZD plunged on the news, but quickly recovered, perhaps because Fonterra also announced an additional support payment of NZD 0.50/kg. Nonetheless, the trend is clear. With the highest nominal and real policy rates in the G10, New Zealand also has the most room to cut rates as global trade slows and commodity prices fall. That means NZD remains vulnerable.

Today’s highlights: The main event during the European day will be the US nonfarm payrolls! The current market forecast for July is for an increase in payrolls of 212k, below the 223k in June. Nonetheless another reading above 200k would suggest that the US labor market is gathering momentum and is likely to keep USD supported against its peers. The July FOMC statement showed more confidence in the labor market than before. A strong NFP reading would confirm this view and add to expectations for a September rate hike. At the same time, the unemployment rate is forecast to remain unchanged at 5.3%, while average hourly earnings are expected to accelerate from June. Bear in mind though that the July figure is notoriously difficult to seasonally adjust, because of auto plant shutdowns and schools getting out, among other factors. Thus the month’s data is more likely than most others to hold a surprise.

• As for other indicators, Germany, France and Norway release their industrial production for June, but none of them is usually a major market mover.

• From the UK, we get the trade balance for June.

• Canada’s unemployment rate for July is also due to be released. Coming on top of the low oil prices, a rise in the unemployment rate could keep CAD under selling pressure.


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