Euro expands as ECB’s balance sheet shrinks
As we regularly talk about in our daily reports, currencies are innately averse to central bank to stimulus in the form of quantitative easing or similar programs designed to inject liquidity in a given economy. As we’ve witnessed out of Japan in recent months, even the premise of a central bank expanding their balance sheet can provide significant headwinds for a currency. The most famous example of quantitative easing is of course the U.S Federal Reserve who currently injects US$85 billion into the economy on a monthly basis.
The European Central Banks answer to ‘QE’ is their Long Term Refinancing Operations, and while major central banks hold their respective stimulus programs on rapid fire, the ECB’s balance sheet is actually shrinking. The Bank said overnight their balance sheet has dropped 159.1 billion to 2.77 trillion Euros as of the February 1 – subsequently the Euro resumed its north bound trajectory. While we can’t suggest currencies are in lock step with central bank balance sheet activity, the correlative value should not be ignored.
Some of the more publicised themes helping the Euro overnight was a better than expected PMI services print. Although the index remains firmly in contraction territory, Euro-Zone services PMI rose to 48.6 in January, against the preliminary print of 48.3. German Services PMI also rose beyond expectations to an index level of 55.7 against the preliminary estimate of 55.3.
And so begins the Euro’s resumption of strength. The currency regained composure across the board overnight after an early week bout of weakness. The EUR-JPY is back at 34-month highs and similar strength can be seen against major counterparts.
The main event for the Euro this week is Thursdays ECB policy decision, which is widely expected to see the bank keep their main refinance rate steady at 0.75 percent. The key focus for Euro pundits and speculators alike will be Mario Draghi post decision address, with many betting on a thinly veiled reference to the negative impacts of a stronger currency. Any rhetoric relating to Euro strength has the ability to take some of the froth off the Euro, but we expect the fear of participating in a beggar-thy-neighbour style of will supersede the desire for Draghi to begin jawboning the currency lower. At the time of writing the Euro is buying 1.3575.
A$ underperforms risk trends; RBA recap
As widely anticipated, the RBA held the official cash rate steady at 3-percent yesterday while flagging the potential for policy easing should downside risks materialise. Although Governor Stevens acknowledged the more positive themes (particularly improvements from a global perspective) the statement left the door for further policy easing well and truly open. “The inflation outlook, as assessed at present, would afford scope to ease policy further, should that be necessary to support demand.”
The statement also expressed the need to wait until prior cuts to the cash rate have penetrated the economy, noting “the full impact of this will still take further time to become apparent”. One again, the high exchange rate received only a partial mention noting the “exchange rate remains higher than might have been expected”.
The usual adjectives were littered throughout the statement, with “moderate” growth in private consumption spending and “subdued” investment outside of the resource sector while noting “the peak in resource investment is approaching.” With the exception of a relatively upbeat global assessment, the statement erred slightly to the dovish side of neutral when referring to the local economy.
In turn, the local unit made a fairly pronounced descent in the period to follow, reversing moderate gains noted on the earlier trade balance release. Selling abated just below 104-figure before a period of consolidation, only to be met with another round of selling throughout U.S trade to lows of 103.69 US cents. While U.S equities appear to be on track to record a day of solid gains, the Aussie failed to receive much of the positive flows with equity strength providing more in way of stability rather than inspiration to drive it materially higher.
Apart from a mildly dovish RBA statement, the Euro received much of the positive attention overnight, which recent activity displaying strength from the Euro can act as a siphon for the Australian dollar in terms of risk flows.
The two major events to come this week will be today retail sales data and January employment data on Thursday. Clearly both of these indicators will be watched closely in the context of the RBA’s next move and a lift in retail consumption and jobs will be needed to quell growing expectations of further interest rate cuts this year.
At the time of writing the Aussie dollar is buying 104.1 US cents.