GBP down further on Brexit fears; UK & Canada CPI, BoJ meeting

Rates as of 06:45 GMT

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Market Recap

The year may be winding down but not the FX market! Big moves in several currencies, not just the collapsing GBP!

For sterling, I could just cut-and-paste my comment from yesterday: concerns that PM Boorish’s Johnson’s plans to enforce a hard deadline for negotiating the trade agreement with the EU has simply recreated the concerns that existed before about a “hard Brexit” or a “no deal Brexit,” just with a different deadline. EUR/GBP and GBP/USD are now back to levels seen before the exit polls started predicting a big majority for the Conservatives. A collapse in the purchasing managers’ indices (PMIs) didn’t help either, although I’m not sure people are watching the economy. Yesterday’s employment figures were better than expected – the unemployment rate was unchanged instead of rising as expected, while employment rose instead of falling as expected – but that didn’t stop sterling from plunging.

I thought sterling would start falling once the new year started, but apparently the market decided not to wait. I think the outlook for the currency is almost as bad as it was before the election – maybe a touch better now that the appalling Jeremy Corbyn is out of the picture, but on the other hand, the UK economy is looking pretty grim and the economic uncertainty is set to last for all of 2020. While other central banks around the world are in a “wait and see” mode, I wonder how long it’ll be before some members of the Bank of England’s Monetary Policy Committee start talking about the possibility of rate cuts. Tune in tomorrow to find out!

NZD was down on a worse-than-expected dairy auction, with the average winning price down 4.8% from the previous auction.

Today’s market

The big event of the day is overnight, when the Bank of Japan Policy Board meets. This meeting is considered “live” insofar as the market sees a 32% chance of a rate cut (albeit down from 42% last week). I’ll get to it in chronological order however so scroll down if you’re interested.

The European day starts with the Ifo survey, a sort of PMI but with questions going to far more firms (some 7,000 in a wide range of industries in Germany). It’s expected to show slight improvement in current conditions but more significant improvement in expectations, which would be a positive indicator for the German economy and positive for EUR.

This compares with Monday’s preliminary composite PMI for Germany, which was unchanged from the previous month, in contrast to expectations of some improvement. Services did improve a bit but manufaturing deteriorated further, much to everyone’s surprise.

Then it’s the UK inflation data. Inflation clearly isn’t the Bank of England’s major problem right now. The headline rate of inflation continues to slow gradually. Core inflation is expected to remain the same, below the Bank’s 2% target. And producer prices are also forecast to fall, indicating that pipeline pressures are also moderating.

Although the result of the Bank of England meeting is announced on Thursday, the meeting itself is being held today. This figure should be available to them in their discussions. I would think it might temper their decision, which in any event I expect will be unanimously to remain on hold for the time being. GBP negative

Next is Canada’s CPI, or should I say CPIs, as the Bank of Canada watches three core measures rather than the one headline. Unlike in Britain, the Canadian CPIs are all at or above the Bank of Canada’s target, and two of the three core measures are forecast to accelerate this month. Already the market is pricing in less than a 50% chance of a rate cut next year, and even a small (7% max) chance of a rate hike. I think further accelreation in inflation is likely to cause the odds to shift further and thereby support CAD.

New Zealand’s Q3 GDP growth is forecast to come in the same as in Q2 on a qoq basis, although the yoy rate is expected to accelerate. That’s higher than what the Reserve Bank of New Zealand forecast (+0.3% qoq), probably due to a much better-than-expected retail trade figure. It should reassure the RBNZ on growth. NZD positive

Australia’s employment data are crucial numbers for that country as the Reserve Bank of Australia (RBA) has set itself the goal of getting the unemployment rate down further. This isn’t going to be the month that it declares victory however; the unemployment rate has oscillated between 5.2% and 5.3% since April and is expected to stay at 5.3% this month. Employment is expected to rise by 10k, which is not a particularly strong showing after the 19k decline in the previous month. All in all I’d say the figures show that Australia’s labor market has plateaued, which may convince the RBA that it needs to goose the market with another wedgie of a rate cut early next year. AUD negative

Bank of Japan meeting

As mentioned above, the Bank of Japan Policy Board meeting is seen as a “live” meeting. That is, the market puts a 32% chance on a rate cut – significantly less than it did a week ago, but still in the “possibility” category.

The BoJ might be thinking of easing this time, because the economy has weakened noticeably in the wake of the October hike in the consumption tax. At the press conference following the October BoJ meeting, BoJ Gov. Kuroda said consumption hadn’t fallen off sharply as it did after the April 2014 consumption tax hike. But recent data shows differently; the BoJ’s real consumption activity index was down 7.4% mom in October, on par with -8.5% in 2014 and -7.7% in March 2011, when the Fukushima tsunami hit.

The Bloomberg consensus forecast is for Q3 GDP to decline 2.6% qoq SAAR. However looking at the results of the 2014 consumption tax hike, a steeper decline seems eminently possible.

Furthermore, last week’s tankan report was worse not good. Manufacturers, historically the driving force of the Japanese economy, did poorly, with the large manufacturers DI falling to the lowest level in almost seven years and expectations for next quarter down as well. Large non-manufacturers showed some improvement, although this wasn’t shared by small non-manufacturers. All in all it was a disappointing result that points to further weakness in the Japanese economy.

However, there are three good reasons to expect the BoJ not to change policy. First off, domestically they will probably want to see the impact of the ¥26trn economic stimulus package that the government recently unveiled. Moreover the government is currently in the process of determining next year’s initial budget. It would make sense for the BoJ to wait to see how fiscal policy is shaping up before changing monetary policy.

Secondly, the Bank may well believe that the downturn is temporary. At the October meeting, the BoJ maintained its optimistic stance even though it said it expects the output gap to worsen temporarily.

Third, the global situation seems to be turning. The other central banks that have had meetings this month – Reserve Bank of Australia, Bank of Canada and ECB in particular — all made comments to the effect that the risks to the global economy “have become somewhat less pronounced,” as ECB President Lagarde said. With most other central banks in a “wait and see” mode, it would make sense for the BoJ to wait too rather than shoot one of its few remaining bullets at what might in retrospect turn out to have been an inflection point.

In short, I don’t think that they will cut rates or adjust policy at this meeting. As a result, I think we could see the yen strengthen somewhat afterwards.

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DISCLAIMER

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‘The key is not to predict the future, but to prepare for it.’ Pericles, 500 BCE

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