Four Things to Know Before the Weekend

Extremely narrow trading ranges have prevailed in the foreign exchange market as what has been an extremely quiet week draws to a close. The biggest mover of the week has been the Australian dollar, which has lost about 0.6% against the US dollar as sentiment reversed following the softer than expected Q1 inflation reading. The other dollar-bloc currencies were a tad softer. 

The other major currencies gained, with the Swedish krona the strongest, with a gain of almost 0.4%. The risk of a rate cut by the Riksbank in June has underpinned flows into Swedish stocks (one of the best performing bourses this week, with a 1.7% gain) and bonds, where the 10-year yield has through France. 

There are four developments to note: Japanese inflation, UK retail sale, rating agencies’ action, and the elevated EONIA.

Japan’s inflation readings were a little softer than expected. The March CPI reading is only of passing interest as the sales tax was hiked at the start of this month. The signal from it is price pressures had stabilized, with the core rate unchanged at 1.3% for the fourth consecutive month. The headline rate did tick up to 1.6% from 1.5%. 

However, it was the April reading for Tokyo that was of the most interest. There was a large rise as expected, but just shy of expectations. The headline rate jumped to 2.9%, not the 3% that the consensus expected, up from 1.3% in March. The core rate rose to 2.7% from 1.0% and the measure excluding food and energy surged to 2.0% from 0.4%. 

Separately, Japan reported that its All-Industry Activity Index slumped 1.1% in February, half again as large a decline as expected and offset a good part of the upwardly revised 1.7% gain in January. This report is a reasonable proxy for GDP, and the weakness shows the fragility of the Japanese economy before the sales tax hike. Next week, brings the Golden Week holidays and some other data that will round out the picture of the pre-tax economy, including retail sales, industrial output and employment. 

UK retail sales offered a modest upside surprise. The consensus called for a 0.4% decline in the headline. Instead, sales eked out a 0.1% gain. However, the February rise was shaved to 1.3% from 1.7%. Excluding autos, retail sales fell 0.4% rather than the 0.5% decline the consensus expected. ONS noted that non-food sales rose 9.6%, the largest increase in a dozen years. 

On the inflation front, note that the price deflator fell to-0.5% from -0.2%. This is the biggest decline since September 2009 (mostly reflecting a decline in gasoline). Next week the UK reports its Q1 GDP. Expectations are for a modest acceleration from the 0.7% quarter-over-quarter expansion in Q4 13. 

There have been a few sovereign rating and outlook adjustments. Fitch upgraded Italy’s outlook to stable from negative. It raised Cyprus’ outlook to stable and raised its rating to B- from CCC. S&P also lifted Cyprus’s rating. Now it is B rather than B-. 

Separately, S&P cut Russia’s rating to BBB- and maintained a negative outlook. This increased the pressure on Russian bonds and the ruble and this in turn, unexpectedly, triggered a rate hike by the central bank. The one-week auction rate, introduced last September, was hiked by 50 bp to 7.5%.

Excess liquidity in the euro system fell below 100 bln euro on Wednesday and stayed below yesterday. This is exerting upward pressure on EONIA, which was fixed just below 30 bp yesterday. This is above the 25 bp repo rate, which is rare outside of month end distortions. Draghi has indicated that the ECB will act against “unwarranted” tightening of liquidity. Indeed, this rather than deflation seems to be the most pressing issue. 

This week’s LTRO repayment announcement will be interesting. We note that Spain has a 15.4 bln euro bond that is maturing next week, the same day that the LTRO repayment settles. If some of this bond was bought with LTRO funds than the maturity may free up them up to be repayed. Although its was other factors that produced the sharp decline in excess liquidity this week, it should be expected that further LTRO pay downs will reduce the excess liquidity further. 

The policy response to the rise in EONIA and decline in excess liquidity is not necessarily a negative deposit rate or QE, but a cut in the lending rate (now set at 75 bp and is ceiling for money market rates) and another cut in the repo rate. A cut in required reserves could also create more excess liquidity. The ECB could also extend the period in which there will be full allotment of repo operations.