British Pound at Center Stage as Bank of England Publishes Meeting Minutes (Euro Open)

The British Pound is in focus in the European trading session as the Bank of England releases minutes from its August policy meeting when it unexpectedly boosted its quantitative easing program by 50 billion pounds. German Producer Prices are also set for release.

Key Overnight Developments

• New Zealand Wholesale Inflation Slips Again in Second Quarter
• Australian Leading Index Grew in June, Says Westpac
• N.Z. PM Key Seeks Single Market with Australia, FinMin Decries Spending

Critical Levels

The Euro yielded an effectively flat result in overnight trading having tried but failed to build upward momentum. The British Pound did inch lower however, losing its grip on the 1.6550 level to test as low as 1.6511.

Asia Session Highlights

New Zealand's Producer Prices remained flat in the three months ending June after two quarters of deflation, following a quarter which saw the largest magnitude in wholesale cost declines since the data began being recorded in 1976. On a yearly basis, input costs fell 1.2%, the first of such cost declines in more than five years. The quarterly data comes during a period in which commodities, as indicated by the S&P Goldman Sachs Commodity Index (SPGSCI) surged 25.6% following a quarter which saw the index remain flat. The interesting fact is that the SPGSCI plummeted 44% in the final three months of 2008. Thus it seems that there is a lag of about three months in the effect that commodity prices have on the cost that producers pay for raw materials. Looking further down the supply chain, output prices fell -0.7%, pointing to downward pressure on consumer prices as wholesale discounting is passed on into the final price tag and allowing the central bank some room to cut interest rates, a strategy that we have advocated previously.

On the other side of the Tasman Sea, Australia's Westpac Leading Index, which gauges the probable rate of economic activity about six months into the future, rose 0.7% in June after the previous month saw the outcome negatively revised to -0.4%. A rise of such proportions would be somewhat expected, given that the Reserve Bank of Australia revised it's growth forecast for the year up to 0.5% from a contraction -1.0% at it's August 6 meeting. Adding to these comments today, RBA Assistant Governor Malcolm Edey said that consumer confidence has returned to high levels, at a speech given at the 7th Annual Retail Financial Services Forum. Despite the optimism Edey was “wary of making any predictions,” he said. Nonetheless “in the past few months there have been encouraging signs of improvement.” The signs here referred to by the Assistant Governor must be primarily linked to the performance of equities, which have surged 27% between the start of March and the end of July. Broader economic conditions have not warranted the optimism, especially since retail sales plummeted when they were expected to actually grow, and especially after full-time jobs continued to be shed in favor of part-time ones.

Euro Session: What to Expect

German Producer Prices are expected to fall at an annual pace of -6.5% in June, the largest drop since records began in 1977. The result will foreshadow continued downward pressure on consumer prices, the headline inflation gauge, as lower wholesale costs filter down into the final price tag. The reading adds to building evidence that Germany and the Euro Zone as a whole may slip into deflation, threatening to leave the economy mired in a long-term period of stagnation as expectations of lower future prices discourage spending and investment.

The European Central Bank has thus far focused primarily on offering banks unlimited borrowing ability, including an unprecedented 442 billion euro in 12-month bank loans, in the hopes that this would be passed on to the overall economy to both stimulate growth and put a floor on prices by making money cheaper. So far, this has not worked: although interbank borrowing costs have stayed well below 0.5% for over two months, this has not filtered through into the economy at large. Indeed, loans to Euro Zone businesses and households grew just 1.5% in June, the lowest since records began in 1991. European banks have yet to come to terms with an estimated $1.1 trillion in unrealized sub-prime related losses (per the IMF), a hit that could be compounded by losses from default or devaluation in some of the newly-minted EU member states, and so may be perfectly content to sit on the money they have borrowed for the time being. The ECB has also flirted with the direct approach, putting in place a 60 billion euro bond-buying scheme. Although it is too early to tell for certain, this seems too small of a program to have any meaningful impact. The bottom line is that greater monetary easing is clearly needed if deflation is to be averted, but the central bank’s neutral posture points to either unwillingness or an inability to meaningfully anchor price expectations. While the Euro has enjoyed robust gains in the four months from the beginning of March on the back of a broad rebound in risk appetite, any return to focus on economic fundamentals could prompt a sharp a sell-off in the single currency.

In the UK, minutes from the most recent policy meeting of the Bank of England are due for release. Mervyn King and company had unexpectedly expanded their quantitative easing scheme by 50 billion pounds and left the door open to further expansion, saying its scope will remain “under review”. Up to that point, the program had largely failed to boost lending to the real economy. Indeed, loans to non-financial firms fell by a record 14.7 billion pounds while the pace of money supply growth fell for the first time in close to a decade in the second quarter. To that effect, traders will be combing through the meeting’s minutes for the rationale behind the BOE’s apparent belief that another 50 billion pounds in asset purchases will make a meaningful difference after the 125 billion pounds that have already been put to work.

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Forex Turnover

Forex Turnover
Main foreign exchange market turnover, 1988 - 2007, measured in billions of USD.
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