Majors Trading Flat ahead of the ECB

BBH CurrencyView

• The dollar is paring back some of its recent losses, with currencies mostly range bound, ahead of the ECB
• The EuroStoxx 600 is currently up 0.25%, with bank shares up 0.8%; S&P 500 futures are essentially flat
• Euro zone sovereign 10-year yields are mixed; Portuguese 10-year down 17bps, Spanish 10-year up 7bps

The dollar is paring back some of its recent losses ahead of ECB policy meeting. The euro is marginally higher, up 0.09%, after falling to a two-day low of 1.321, while sterling edged higher, currently trading at 1.585, after another set of encouraging UK economic release. The BoE, as expected, extended QE by another £50bln. The Australian dollar was stable around 1.080 after hitting a low in the Asian session of 1.074. The New Zealand dollar is among the top performers in the G10 in spite of a softer Q4 employment print. Elsewhere, during the Asian session China CPI accelerated to 4.5% y/y, but numbers may have been exacerbated by the Lunar New Year and the break down revealed that price pressure were still easing. The MSCI Asia Pacific index was close to flat, up 0.06%, after trimming earlier session losses.

The fact that the euro zone finance ministers group is meeting tonight at 6 PM Brussels time had raised hopes that a deal for Greece was close. However, after meeting with Greek coalition members last night, Prime Minister Papademos has yet to close the deal, with press reports that pensions remain a key sticking point. Media reports suggest that as a result, the Troika will give Greece time to come up with EUR300 mln more in savings. Reports of where the deadline falls differ, but given the legal and technical hurdles to overcome in order for Greece to meet its March bond payments, we do not think it can be extended by more than a few days. Draft documents suggest Greece has capitulated on the key issues of deeper cuts in minimum wage and additional reduction of civil service workers. The IIF also appears to have capitulated on PSI after it had said that 4% coupon for the new bonds was its last best offer. Reports now suggest 3.5% coupon for the new bonds. The ECB also meets today, and while no change in policy is expected, markets will be watching the press conference afterward to see if Draghi will offer any clues on future policy. Technical studies suggest potential for a move up to 1.3435 for EUR/USD, but believe much will depend on Draghi’s tone during the press conference.

On the data front, UK December production expanded 0.5% in December, beating market expectations. The improvement was driven by a 1% rebound in manufacturing production, which also came in better than expected. However, the Office for National Statistics (ONS) revised Q4 industrial production down by 1.4%, indicating a slightly larger decline than initially assumed in the initial Q4 GDP estimate. The ONS nevertheless said this revision would only have a marginal impact on Q4 GDP, with industrial production only accounting for about 15% of GDP. That said, despite the backend revisions the production data are still encouraging, especially given that January’s manufacturing PMI are pointing to ongoing improvement. Following the announcement of further QE this morning we expect that many observers are already looking ahead to the February inflation report and the minutes from the February MPC meeting. Markets will be looking for guidance from the MPC about its expectations for inflation over the coming years. For instance, if the MPC continues to forecast inflation below its 2% target over the next two years, the risk of QE will increase if the momentum in economic activity begins to slow. Sterling resistance is seen near the 200dma (1.594), with near-term support seen at 1.580.

In China, Inflation exceeded expectations by a significant margin, rising by 4.5% y/y. Much of it can be explained by food inflation due to the Chinese New Year (+10%). But that’s unlikely to be the whole story, strong domestic demand surely plaid a role as well. The reaction in local markets was not as strong as one would expect. SHIBOR rates are only marginally lower despite widespread commentary that RRR are off the table for now. We agree that the data will likely delay RRR and refocus the markets on inflation risks, but it does not change our view that the big risk this year is on the growth side and that policy will continue to move towards a more accommodative stances.

The Indonesian BI surprised markets with a 25bp cut to 5.75%. In its official statement the bank downplayed the impact of the energy price increases expected for later in the year and played up the risk to global growth. The bank sounded more confident about rupiah, which is now seen as “quite stable although slightly depreciated.” We think that implicit in the rate cut decision, the bank is signaling that it remains committed to defending the currency from eventual depreciation pressures and has a preference towards a stronger currency. As such, we still see the upside risks for USD/IDR as more limited than for other EM Asia currencies at this juncture.