Forex Trading

Euro volatility looks likely in the coming session as the European Central Bank issues a highly contested interest rate decision, with expectations calling for policymakers to keep borrowing costs at 1% despite mounting pressure to provide greater monetary stimulus and a growing deflationary threat.

Key Overnight Developments

• Australian Trade Deficit Widens Five Times More Than Expected
• Euro Declines Against US Dollar Ahead of ECB Rate Decision

Critical Levels



The Euro drifted lower in Asian trading, slipping as much as -0.4% against the US Dollar ahead of the ECB interest rate decision. The British Pound is little changed ahead of the opening bell in Europe having oscillated in a choppy range below 1.65 for much of the overnight session.

Asia Session Highlights



Australia’s Trade Balance deficit widened much more than expected, showing a –A$556 million shortfall in May. Economists were forecasting a –A$125 million result ahead of the release. Exports fell for the third consecutive month, shrinking -5.2%. Annual revenues from overseas sales of coal and iron ore, Australia’s top export goods, registered the smallest increases in at least 7 months, rising 2.4% and 7.2% respectively. Looking at Australia’s top trading partners, shipments to Japan and the UK led losses, falling -13.2% and 11.2% respectively; exports to the US, South Korea, and India also saw notable declines. That said, sales to China, Australia’s largest trading partner, grew 9.4% from April and may continue higher considering recent data showing the Asian giant’s manufacturing sector grew for the fourth straight month in June. Notably, China’s state media reported that the country plants to stop stock-piling commodities; if true, this could weigh on Australian exports in the months ahead. On balance, a survey of economists conducted by Bloomberg expects a negative net impact from foreign trade on economic growth for the foreseeable future, with net exports trimming an average of -5.5% off GDP through the end of next year.

Euro Session: What to Expect



Euro volatility looks likely in the coming session as the European Central Bank issues a highly contested interest rate decision. The central bank is facing mounting pressure to provide greater monetary stimulus, with the Paris-based Organization for Economic Cooperation and Development (OECD) urging the central bank to cut borrowing costs toward zero and keep them there into 2010 while Credit Suisse’s overnight index swap index reveals traders are now pricing in a 59.9% chance of a 25 basis rate cut, a sharp reversal considering they were reflecting a 62.7% chance of a rate hike just a week ago.

Looking past the admittedly global phenomenon of dismal economic growth in 2009, arguably the most pressing reason to reduce the cost of money is to check the onset of deflation. An early CPI estimate revealed that prices shrank at an annual pace of -0.1% in June, the first negative reading on record since the creation of the single currency in 1991. The latest Producer Price Index data supports continued pressure on consumer prices, with forecasts calling for wholesale inflation to shed -5.6% in the year to May. Entrenching expectations of lower prices threatens to commit the currency bloc to a long-term period of stagnation as consumers and businesses are encouraged to wait for the best possible bargain and perpetually delay spending and investment.

For their part, a rotating cast of ECB officials including President Jean-Claude Trichet have said last week that current rates are “appropriate” for the time being, with perennial hawk Axel Weber saying the bank has “used the room for rate reductions that was created by waning inflation risks,” adding that “additional steps are not necessary.” Although the ECB did offer an unprecedented 442 billion euro in 12-month bank loans as a means of de-facto monetary easing and will also move forward with a 60 billion bond-buying scheme announced at the last policy meeting, these measures may prove woefully inadequate, as there is no guarantee that banks will lend out the funds raised from action and thereby stimulate the broad economy. Indeed, banks may chose to hang on to the cash as a buffer against $1.1 trillion in as yet unrealized losses linked to the subprime mess, per the IMF, as well as the fallout from a developing currency devaluation in Latvia. Still, the ECB appears unfazed and seems resolved to trade away economic performance to assure inflation is kept in check, with ECB member Jurgen Stark openly suggesting that GDP growth may say low “for years to come”. Barring any dovish surprises, this opens the door for traders to punish the Euro as they price in expectations that the region will substantially lag behind other industrial economies in recovering from the current downturn, forcing interest rates to stay lower for longer than elsewhere.

Written by Ilya Spivak, Currency Analyst
Article Source - Euro Volatility Likely as European Central Bank Announces Interest Rates (Euro Open)