The flash estimate of Eurozone CPI inflation dropped unexpectedly to just 1.2% YoY in April, a fall that will make the ECB Governing Council sit up and take note at Thursday’s monetary policy meeting. The reading was a low since February 2010, but there are few additional details given that it is the flash reading. The growing concern on the Governing Council going is that inflation may undershoot the target at the forecast horizon. Inflation is slowing faster than anticipated, although again it is not yet clear whether the drop in April was caused by any one-off factors that could reverse. Either way, another rate cut is looking increasingly likely in coming months given the turn back lower in recent economic data. The majority of economists surveyed by Bloomberg now expect the ECB to cut the refi-rate by 0.25% to 0.5% on Thursday. We expect another “no change” decision but with a dove-ish press conference to follow. There appears to be a greater possibility that the ECB initiates further measures to improve the Eurozone monetary policy transmission mechanism via more direct bank lending (ECB balance sheet expansion) but we acknowledge a cut to the refi-rate is also a real possibility. Interestingly, the EUR ignored the CPI release this morning and continues to hover in the 1.3050-1.3100 range.
The USD is likely to remain heavy; in line with low US bond yields and the prospect of another dovish FOMC statement on Wednesday. US ten year bond yields closed on Monday at 1.67%, just 1bp above their lowest level in 2013. The FOMC’s two day meeting starts today. We expect no change in Fed policy nor any material changes in the post-meeting statement on Wednesday. In our view, the weakness in US growth and very low US inflation (PCE inflation is only 1%pa, below the levels where QE1, QE2 and QE3 were introduced) are likely to encourage the FOMC to continue buying US$85 billion of assets per month, until at least early 2014, which should keep the USD heavy. (see attached PDF for our full preview)
GBP/USD has under-performed over the past 24 hours, despite a softer USD. UK credit data again remained disappointing in March. We maintain our current strategy of selling into GBP/USD rallies, but have suggested participants wait for a rally to 1.5600 before selling. From a technical perspective, the 50% retracement level from GBP/USD’s January high of 1.6381 and its March low of 1.4832, rolls in around 1.5607. Depreciation pressure remains on GBP/USD led by the combination of negative real interests and a current account deficit at a 22 year high of 3.7% of GDP. Today’s UK March consumer credit and April consumer confidence numbers are expected to remain soft (9.30am BST).
AUD/USD has edged a little higher, encouraged by gains in global equity markets, declines in global credit spreads, and a lift in base metal prices. Low inflation readings yesterday in Europe and the US, accompanied with softening economic data in both regions, indicate US and European quantitative easing policies will remain in place this year, providing support for Australia-US and Australia-Europe interest rate differentials. In fact, the risks are swinging towards more QE in both the US and Europe; the ECB’s additional monetary easing could come as early as Thursday. Locally, Australian credit data for March today did not influence the AUD, which has been well-supported in Asian trade slightly above its 2.5 year average of 1.0310.
NZD/USD has also been buoyant in Asian trade, and is back trading around 0.8550 at the time of writing. The April ANZ Business Outlook showed broadly stable and high NZ business confidence. Separately, data showed the annual pace of housing credit growth has lifted to 4.6%. At the April OCR review, the RBNZ reiterated it did not want to see “financial or price stability compromised by housing demand getting too far ahead of supply”, so credit aggregates will be important piece of the NZ puzzle over coming months.
The next data focus for AUD and NZD is the April China Manufacturing PMI due tomorrow (9pm EST/2am BST). We expect the PMI to remain indicative of a Chinese economic expansion, and print around 50.8 for April (market expectations 50.7, March’s reading 50.9). A print at or above market expectations should provide support to AUD and NZD in Asian trade tomorrow, particularly with the USD expected to remain heavy ahead of the FOMC.
USD/JPY continues to consolidate, as flagged yesterday. Japanese industrial production disappointed today, lifting only 0.2% in March to be down 7.3% on the year-ago level. Industrial production was the key Japanese release this week because it has a correlation with Japanese exports and Japanese GDP. We continue to expect that JPY will consolidate following the large movement over the past 6 months, where USD/JPY has lifted nearly 30%. We expect USD/JPY can edge lower towards the 30-day moving average of 96.85, given the low level of US 10-year government yields, and the associated narrowing of the US-Japan interest rate spread. But the collapse in Japan’s current account surplus suggests buying USD/JPY between 96.85 and 96.50 should work well over the medium-term.