Prepare for this week’s monetary policy decisions

With no clear solution yet in sight for the eurozone, the Bank of England (BoE), the European Central Bank (ECB) and the Reserve Bank of Australia (RBA) are holding their monetary policy meetings this week.

Is an interest rate cut in Australian interest rates a done deal?

Data showed that Australia’s economy may be slowing down. Retail sales fell unexpectedly in December while the latest job figures support the view that the Australian economy may be affected negatively by the growing eurozone debt crisis. In addition, inflation is no longer a threat for RBA as the strong Aussie drove down prices and eased inflation pressures. It appears that the strong Aussie further justifies speculation for a rate cut on Tuesday February 07 at 03:30 GMT. Against the dollar, the Australian dollar jumped to a six month high and versus the single currency it reached a record peak. The significantly better than expected jobs data from the US was translated to hopes for an improved global economic outlook supporting the Aussie.

In the scenario where RBA keeps the benchmark interest rate at 4.25%, the Aussie may strengthen as the market is pricing in a 25 basis points rate cut on Tuesday. It will be a difficult decision for RBA policymakers as the global economy does not appear to be as dark as it was in late 2011. However, based on the softer inflation pressures, the strong Aussie, lower consumer spending and weakening economic growth RBA may cut interest rates to 4% causing the high yielding currency to drop.

More QE by the Bank of England?

The BoE is also expected to hold its monetary policy this week on Thursday February 9 at 12 GMT. As the UK economy is struggling to prevent a double dip recession, the BoE is expected to launch another round of quantitative easing (QE). Investors expect the central bank to announce a 50 billion pound expansion of its asset purchasing program and leave interest rates unchanged at 0.5%. In October, the bank announced a further 75 billion pound expansion of the QE program and since the program started in March 2009, 275 billion pounds worth of bonds were purchased.

Recent economic data showed that the UK Manufacturing and Services sector rose to the highest level in ten months. Also, positive data from the eurozone and strong jobs numbers from the US further strengthened optimism in the market. Thursday’s decision is not easy for MPC policymakers. In the scenario where the central bank announces to pump 50 billion pounds into the UK economy, sterling may be put under pressure seeking new lows. In the scenario where no change in the QE programme is announced, sterling may strengthen on hopes that the UK economy is now on the road to recovery.

Focus on the European Central Bank monetary policy decision

Investors’ eyes will also be turning to the European Central Bank policy meeting due on Thursday February 9 at 12:45 GMT. As the eurozone debt crisis deepens, the ECB has injected billions of euros into the banking system in order to support the ailing economy. Economists forecast that the eurozone may be entering recession in 2012 while European leaders struggle to achieve a better fiscal union. Government bond yields of Italy, Spain and France retreated from unsustainable levels while Greece is in the middle of talks with its private creditors in order to reach an agreement to avoid default. In the scenario where a rate cut of 25 basis points is announced, we may see the euro weaken as the market is uncertain about ECB’s next move. In the scenario, where interest rates are kept unchanged then euro may find support.

Investors’ real focus will be on the press conference by ECB President Mario Draghi at 13:30 GMT, where signals for the future monetary policy will be closely watched. In a scenario where Draghi emphasizes on the heightened eurozone debt contagion risk and adopts a dovish stance, expectations for additional easing and a possible zero interest rate policy may rise. This may trigger a sell-off in the euro. Whatever the outcome, Thursday will provide an insight into Europe’s future economic picture.

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