Euro Slides Ahead of BOE and ECB Meetings

The euro was recovering in early Europe, moving back toward the upper end of its recent narrow range and it reversed course sharply, triggering stops along the way as it dropped nearly a cent to $1.2695.  The technical failure yesterday at $1.2820 may also have been more telling.  Despite the extend positioning and sentiment, what could have turned into a upside correction in the euro has not really gone beyond the consolidation (in the trough). 

Previously support in the $1.2720-40 area should now act as resistance.  The euro needs to move above there to stabilize the tone.  Barring that the multi-month low set on Monday near $1.2666 look vulnerable. 

The drop in the euro dragged down the other other major currencies and "risk-on" trade was generally reversed.  The real trigger is elusive.  Some observers link to Fitch's comment calling on the ECB to buy more sovereign bonds, but this is not new.  The major rating agencies have made this point previously. 

News from the German stats office that its economy may have contracted 0.25% quarter-over-quarter in Q4 is a bit disappointing as some hoped for stagnation.  The full details are not officially released until mid-Feb.  The timing of the stats office release did not correspond with the euro's slide. 

The Bank of England's policy making committee begins a two-day meeting today.  Its current gilt purchases program is not complete and when it is, the BOE is likely to announce another 50 bln gilt purchase program.  The recent string of surveys have fared better than expected, but there is no doubt the UK economy is fragile. 

Moreover, bank lending conditions are tightening.  Easing inflation pressures, partly a function of base effects, will give the BOE the latitude to continue to ease monetary policy via quantitative easing.   When the BOE doesn't do anything, it doesn't say anything. 

The ECB, like the Federal Reserve, says things even when it does nothing.  This will be the case tomorrow.  After cutting rates twice in the last two months of the year, the ECB is likely to keep rates on hold at the historic low of 1%.  The next cut, and we do think there is at least one more, is significant.  The corridor in which the repo rate is in the middle is the deposit rate (0.25%) and the lending rate (1.75%).  The next cut in the repo rate will have important implications for either the magnitude of the corridor or reducing the deposit rate to zero. 

Banks are parking record levels of euros (486 bln) at the ECB's overnight facility,  In the private sector this would be sending a pricing signal that the ECB is under-charging for its services and a cut in the deposit rate should be considered.    These decisions can be made when more data is available to shed light on the magnitude and duration of economic downturn.  The full impact of the 50 bp rate cuts have not yet worked their way through the system.  Some of the measures that the ECB has taken in terms of liquidity have not been fully implemented yet.  Pausing now underscores the significance of what Draghi has done since taking the helm.