Central bank shenanigans

Today’s news headlines:

  • ‘House prices would crash by a third in no-deal Brexit, says Mark Carney’ Bank governor warns cabinet soaring mortgage rates could wipe 35 per cent off market. (The Times)
  • ‘Italy’s stock market regulator chief resigns after political pressure’. Mario Nava has resigned saying he was leaving due to an ‘issue that is only political’ after weeks of mounting pressure from the new government. (The Financial Times)
  • ‘ECB’s Draghi should help Italy, “not just criticise” – Salvini’. The ECB’s Italian Chief Mario Draghi earlier told reporters in Frankfurt that suggestions by Italian policymakers that the country’s 2019 budget may fail to comply with EU norms had impinged on the economy and hit financial markets. (Reuters)
  • ‘Japanese PM Abe: Don’t think easing should go on forever’ The Japanese Prime Minister noted, however, that he would leave the exit from economic easing up to central bank governor Haruhiko Kuroda. (Market News)
  • Federal Reserve’s Raphael Bostic on Thursday reaffirmed his commitment to move US interest rates towards neutral, in light of above-trend growth. (Market News)

Thursday’s Bank of England (BoE) meeting passed with little surprise. The BoE voted unanimously to maintain the benchmark interest rate at 0.75%, as expected. The Bank’s upgrade to Q3 output and recognition of stronger consumption and pay growth support our view that if an orderly soft Brexit occurs, the rates market will need to price in the reality.  An economy approaching its supply capacity suggests at least two rate rises in 2019. A rates market repricing should lead Sterling significantly higher.

The European Central Bank (ECB) may have initially disappointed market expectations on Thursday, but its optimistic view on the economy and inflation’s convergence to target, left the Euro higher on the day. In its initial press release, the ECB confirmed an October start to the winding down of its bond purchases. However, it kept a potential December end to bond buys open. This is the ECB’s insurance policy, in case one of the myriad risks to the Euro Area crystallises. The Euro traded lower, disappointed by a lack of commitment to a December finish line.

However, in the follow-up press conference, Draghi’s reassurance on the economy managed to lead the common currency higher. The recent weakening in activity data and speculation of economic forecasts downgrades meant markets were positively surprised when the 2018 and 2019 growth expectations were shaved by a mere 0.1 percent, a downgrade that was due to weaker external, not internal, demand. The message was clear—the Eurozone has grown above potential for some time. The recent slowdown was the Eurozone getting back on track after travelling in the fast lane for a while.

The US Consumer Price Index (CPI) added to the move higher in the Euro to US Dollar (EUR/USD) exchange rate. The measure of core annual inflation fell to 2.2% in August from 2.4% in July. The decline was largely due to a sharp drop in volatile clothing prices on the month. However, the moderation in headline CPI followed news on Wednesday of an easing in underlying producer prices in August. Market positioning shows that bets are high that the US Federal Reserve will continue to tighten policy. The consecutive disappointments in inflation prints unnerved these bets, and the Dollar traded lower as a result.

Antics from Turkey also jolted currency markets. President Recep Tayyip Erdogan was quoted as saying ‘we should cut this high interest rate’. He also suggested using laws against excessive price rises. His comments undermined the institutional credibility of Turkey, and the Turkish Lira (TRY) fell 3% against the US Dollar (TRY/USD). A few hours later, in a gutsy move to reassert its independence, Turkey’s central bank raised rates to 24.00% from 17.75%. This rebuke to Erdogan’s incursion on the Bank’s independence led the Lira to reverse all its losses and trade 2.8% higher on the day. The move also led to a risk-on tone to markets with emerging market currencies supported and safe-havens left to underperform.

The main release Friday will be US Retail Sales data. The strength of wage growth and recent spending data suggest that US consumer has the means and the inclination to see a strong print. Expectations for US Industrial Production are high after the strongest ISM Manufacturing print in three decades. The University of Michigan Consumer Sentiment Index will end the data releases for the week. With political instability in the White House and escalating trade wars, this will be an interesting read on America’s view of the economy. ECB's Nowotny, BoE's Carney and Federal Reserve's Evans are due to speak throughout the day.