Forex Trading

The forex market looks set for a volatile session in European trading hours as a murky outlook ahead of interest rate announcements from the European Central Bank and the Bank of England is sure to catch at least some market participants off-guard. The Euro and the British Pound both slipped lower against the US Dollar in overnight trading.

Key Overnight Developments

• Australian Trade Surplus Widens in January as Imports Plunge
• Euro, British Pound Pull Back Ahead of Interest Rate Announcements

Critical Levels



The Euro lost as much as -0.6% against the US Dollar in overnight trading, testing below the 1.26 level. The British Pound also saw selling pressure, testing as low as 1.4133. For complete analysis of all the major currency pairs, please see the latest weekly technical outlook report.

Asia Session Highlights



Australia’s Trade Balance issued a narrower surplus than expected in January, printing at A$970 million versus forecasts of a A$1.1 billion result. Still, the reading marks an improvement over a revised A$414 million surplus registered in the previous month as a drop in imports (-7.3%) outpaced the decline in exports (-5.0%). Consumer spending is likely to remain sluggish in the near to medium term as falling consumer confidence and a rising unemployment rate trim demand, opening the door for continued improvement in trading terms. On balance, the current trajectory sets the stage for strength in the long term outlook for the Australian Dollar against currencies corresponding to countries/regions where the external balance is expected to continue to deteriorate, such as the Euro and the Yen.

Euro Session: What to Expect



Signs of deepening recession will be on full display ahead of the pivotal interest rate announcement from the European Central Bank: German Retail Sales are expected to have decline -0.7% in the year to January, the third consecutive contraction; French Producer Prices are set to issue the first negative print in over 6 years, falling -0.4% in January from a year before; finally, the overall Euro Zone Gross Domestic Product is likely to show that the regional economy shrank -1.5% through the fourth quarter and -1.2% from the three months ending December 2007, the worst performance since the introduction of the single currency.

Against this backdrop, ECB president Jean-Claude Trichet is expected to announce a 50 basis point rate cut to bring the benchmark borrowing costs to 1.50%. Overnight index swaps suggest the reduction has already been priced in by the market, but also reveal that traders expect the central bank to shift to neutral going forward. Such as decision would take as given that economic activity will at worst find a stable bottom through this year, averting a slide into deflation. If the downturn lasts longer than currently expected however, the ECB may find itself forced to play catch-up having been noticeably less aggressive than other major central banks in easing monetary conditions. Indeed, while the European Commission expects the collective Euro Zone economy will shrink -1.9%, a survey of economists conducted by Bloomberg calls for a bleaker outcome at -2.2%. The implications for the Euro are decidedly bearish: the ECB has diligently built up expectations that rates will stabilize at 1.50%; an unexpected dovish shift in the commentary accompanying today’s release is likely to put significant selling pressure on the currency as traders scramble to price in the new yield outlook.

Considerable uncertainly also hangs over the interest rate announcement from the Bank of England. Economists’ forecasts call for a 50 basis point reduction to bring borrowing costs to a new historic low of 0.50%. Importantly, the market looks unconvinced for now as overnight index swaps show traders pricing in a neutral outlook for the next 12 months. This is not without reason: minutes from the last policy meeting revealed a reluctance to take rates lower for fear that this would hurt bank profitability. Rather, the MPC voted unanimously to seek government approval for quantitative easing. On the other hand, a pair of statements from BOE officials last week bolstered a dovish bias: Andrew Sentance warned of deflation and said there is “a strong case for providing additional stimulus” while David Blanchflower called monetary policy "overly restrictive". All told, British Pound volatility is the one thing that can be reasonably expected as the multitude of conflicting leads ahead of the BOE announcement is sure to catch at least some market participants off-guard.

Written by Ilya Spivak, Currency Analyst
Article Source - Forex Volatility Ahead on ECB, BOE Interest Rate Announcements (Euro Open)