After the FOMC: Norway and the UK

Last week, the policy focus was on the Swiss National Bank, the BOJ and ECB. The SNB lowered its 3-month libor target and pumped up its money supply (sight deposits). This action seemed to force the BOJ's hand. Once the moved, if the BOJ didn't, it would have increased the upside risk on the yen as the "easier" safe haven play. The ECB in some ways responded to the pressures by re-introducing the 6-month refi facility, extending the 3-month refi operations into next year and resuming its bond purchases. At first it seemed reluctant to buy Spanish and Italian bonds, but changed its stance following new austerity commitment in both countries.

The focus today is on the FOMC. In light of the 0.8% growth in H1 and the increased market turmoil--which may have knock on effects through sentiment and the wealth effect--as well as the fiscal drag implicit in the debt ceiling resolution--if the Fed does not do anything new, Bernanke and Co risk disappointing the market and the fallout that may follow. QE3 at this juncture does not seem a likely and few observers disagree.

After the FOMC meeting is out of the way, the policy focus will shift the Norway and the UK. Norway's central bank meets tomorrow. In June it warned that its key rate of 2.25% would likely be 2.75-3.0% by year end. This is encouraging many observers to expect a 25 bp hike tomorrow. The risk seems to be in the other direction. Given the market turmoil and the weakening growth profile among many key economic centers, Norges Bank may hold steady, leaving the krone vulnerable.

Prior to the central bank meeting, Norway will report July CPI figures. These will also show why the Norges Bank need not be urgent. July will likely be the third consecutive month headline CPI declines. The consensus calls for a 0.4% decline the same as in June and that follows the 0.2% decline in May. The year-over-year rate may rise to 1.5% from 1.3%, but this is down from the 2.0% peak in January and 2.8% in Dec 2010. The underlying (core) rate may rise from 0.7% to 1.0%. In April, the peak for the year thus far, was 1.3%, which is also where it was a year ago (July '10).

Turning to the UK, the BOE does not meet, but it does issue its inflation report. This is often not a significant market mover. However, BOE is likely to cut its growth forecasts for this year (and maybe next). Today's unexpected drop in industrial production and manufacturing underscores the weakness of the economy. The UK economy has largely stagnated over the past 9 months. Inflation pressures appear to be easing, but are still elevated.

The minutes from last week's BOE meeting will be published later this month, but there is already a strong suspicion that the dissenting hawks at recent meetings have weakened in the face of the economic data. Cutting the growth forecast will be both the cause and effect of stronger centrist/dove views. It is an important step toward a resumption of asset purchases, which remains a distinct possibility before the year is out. Sterling's resilience has been impressive. Since July 21 euro zone agreement, the Swiss franc has been the best performer by a long shot (10.2% against the dollar. The yen has been second, net-net appreciating 1.4%. Sterling is in third place among the G10. It has been flat in that time period. By comparison Norwegian krone has been in the middle of the pact with a 1.8% decline.

Despite the compelling economic logic, quantitative easing is not always associated with a weakening currency, much to the dismay of Japan and Switzerland, for example. Sterling's outlook may be more a function of the dollar's underlying direction. It is trading comfortably, even if choppy, in a roughly $1.62-$1.6450 trading range since July 21. Technical indications, however, do suggest that the downside may be more vulnerable. However, the best way to express the view in the currency market is through the euro sterling cross.

UK gilts may be attractive, given the economic data, but they have already benefitted from the market turmoil. Ten year yields have fallen 54 bp over the past month, compared with 64 bp decline in 10-year Treasuries and a 46 bp decline in 10-year German bunds. Swedish 10-year bonds yields, not often thought of as a safe haven, have fallen by 59 bp.

Note that S&P today opined that contrary to speculation in some quarters, a downgrade of UK's sovereign rating was not imminent. It seemed to suggest the UK had a couple of year and reaffirmed its stable outlook.